Relationship between incomes, maximum mortgage loans, and purchase prices in the CRD

My recent post on housing in BC, looking at the rates of household formation and new residential construction (can be found here) got me thinking - Based off of incomes, what is the maximum price which a household could afford when buying their residence?

In order to calculate this maximum, we need to know a few things.

1. What is a household's gross income?
2. What are the qualification criteria for a mortgage?

Well first, to address households gross income. Such data is not publically available at a household level. Instead what is available are mean and median household incomes, as well as incomes by household according to set income brackets.

For example, In the Greater Victoria Area (CRD), from the 2011 and 2006 census:

• 2006 Median household income: $61,553 and Mean household income: $76,711
• 2011 Median household income: $67,041 and Mean household income: $78,583

giving us an annual growth rate of Median and Mean Incomes equal to

• Median household income growth rate: 1.72% per year
• Mean household income growth rate: 0.48% per year

If we make the assumption that these growth rates are roughly constant, then we get:

• 2016 median household income: $73,008
• 2016 mean household income: $80,487

Then if we refer to the CRD gap analysis conducted in August 2015 which breaks the CRD population into different sized groups based on incomes. primarily the findings are:

Armed now with an estimated 2016 mean and median, as well as a bit of distributional information as to what percentage of the population fits into each category, I can now generate a simulated distribution of household income to approximate the above information.

Doing so we get a simulated income distribution of the CRD with:

• Simulated Median household  income: $71,527
• Simulated Mean household income: $80,704
• Simulated Min household income: $0.2
• Simulated Max household income: $1,551,000
• Simulated Standard Deviation of household income: $61,692

which gives us an estimated income distribution for 2016 which looks like:

Next let's move to determine what is the maximum mortgage amount each household could qualify for, given their income.

To do so we need to make some general assumptions.

1. Property taxes are constant at 0.8% of property value.
2. The cost of heating one's home when averaged over the year is $100/mo.
3. after considering the monthly payment for heat, property tax, and the mortgage, all other monthly debt payments account for less than 7% of a household's gross income. 
4. The interest rate at which a household is qualified at is the 5 year fixed rate as posted by the Bank of Canada -- 4.64% as of the time I am writing.

These assumptions are needed due to the qualification requirements which are (simplified for this):

• no more than 35% of gross income will be spent on Mortgage, Property taxes, heat.
• hence the need for assumptions 1, 2 and 4.
• no more than 42% of gross income will be spent on total debts. 
• hence the need for assumption 3, as well as the others.

Recall we are looking at calculating the maximum mortgage or loan amount each household would qualify for given their income and the above assumptions. This does not mean the maximum purchase price they could afford as we have made no assumptions about the buyer's equity and down payment -- thus if we were to assume that buyers have only the minimum down payment available, then maximum mortgage amount would be expected to be similar to the maximum purchase price. 

Note: currently the Median price in the CRD is $645,000 while the Mean price is: $752,509

With these assumptions, we can calculate the maximum mortgage payment for each household, then if we work backward, figure out the maximum mortgage amount each household could afford. This can be seen below:

If we interpret this graphic we see that the average maximum mortgage (loan) amount is in the realm of $365,919 while the median maximum is at $321,128. 

Comparing these maximum mortgage amounts to the average and median purchase prices we are currently seeing in the CRD we have a large discrepancy. The big issue here is that clearly, not all households can afford to own, those who make up the bottom of the income distribution simply do not have the means to achieve home ownership. Thus, following the lead of the CRD gap analysis previously referenced, let's assume that only those households earning $80,000 a year or more are able to afford to buy a house. 

If we invoke this assumption, then we get a truncated distribution of maximum mortgage amounts, and a revised higher mean and median maximum mortgage, which can be seen below:

By eliminating the bottom part of our income distribution by assuming they are not able to participate in the housing market, we obtain a new, higher mean and median max mortgaged amount. Still, there seems to be a gap between these values and those of the mean and median purchase prices. for reference:

• Median max mortgage $551,991 Vs Median purchase price $645,000.
• Mean max mortgage $596,135 Vs Mean purchase price $752,509.

Based off of this we can begin to infer that: 

1. Households are making massive down payments allowing them to reach purchase prices much higher than their maximum qualified mortgage amount.
2. Given the recent inflation of house prices in the CRD, $80,000 a year is no longer representative of the threshold household income required to enter the housing market. 
3. We may not be able to actually make inferential statements by comparing the maximum mortgage amounts and present purchase prices.

My last question becomes. If it is true that $80,000 is no longer the threshold household income to enter the housing market, which level of household income would yield a maximum mean and median mortgage amount similar to present housing prices?

The answer to that is a threshold household income equal to $125,000 yielding:

• Median max mortgage $678,200 Vs Median purchase price $645,000.
• Mean max mortgage $755,800 Vs Mean purchase price $752,509.

That is at this price, only the top 19.78% of households (roughly 1/5) could reasonably be expected to be able to participate in the housing market in the CRD.

What are your thoughts? feel free the comment below!

Millennials, Coffee, and Savings

I came across this recent article on Munchies.Vice by Nick Rose that examines the results of a recent survey by investing app acorns.

The entire article can be found here.

At first, I was genuinely shocked at the finding that Millenials are spending more on coffee than retirement!

Then I pulled up my own banking information and was again equally shocked - as prudent I thought I had been towards savings - turns out I still enjoy my coffee today much more than my spending tomorrow.

What are your thoughts? Have you fallen into the same trap?

I wonder if there is a difference if we look at all savings, not just retirement. If we are consuming more coffee than we are putting away for retirement - is the same true for what is being saved for down payments for first homes?

If so, that dream of home ownership seems to be slipping further away. But then again, maybe I can just drink some coffee, enjoy today, and the BC government will finance my downpayment for me!

On the different measures of GDP

Another semester kicking off and once again time to demonstrate and explain different measures of GDP and why we have different measures.

For those interested (bit of a rabbit hole of links), here is a link to a short review of an article by Philip Cross at the CD Howe institute on the subject matter by Dr. Giles at Uvic, as well as a link to the complete article (which in its self is fairly short).

Interesting read and insight for sure!

BC Housing markets

With the liberal government recently announcing (well almost a month ago now) that they would help first time home buyers with their down payment through an interest-free loan program (for first five years - more info can be found here) this got me thinking,

As many have commented, on the spectrum of purely political policy to good economic policy, this falls pretty close to the political extreme. Rob Gillezau has an excellent piece in Macleans titled "BCs new subsidy for homebuyers is pure politics and bad policy", where he discusses this further.

I don't overly want to discuss the actual policy being implemented here, but rather the idea of the housing market. I often hear from students and others that the price of housing is too high, that it should be much lower.

My response to this is usually along the lines of "what determines the price of a good?" - in this sense, where the sellers' minimum willingness to accept meets the purchasers' maximum willingness to pay, or put another way, when supply equals demand. Thus the price for housing from a natural perspective is neither too high or too low, but rather where it should be as determined by market forces.

This does not mean that the price of housing is right from a social perspective, so we begin to try to determine what is a "fair" price - the problem is, what is a "fair" price, and "fair" for who? As soon as we begin to try to pin a "fair" price onto a market, we are constructing an artificial price, and distorting the market (No comment as to whether this distortion would be good or bad! simply that it is a distortion).

So, back to the market price, where we are currently at. Gillezau in the above-mentioned piece, as well as many others (myself included), have contributed the rapidly rising house prices in BC to be due to a supply shortage. That is demand is rapidly increasing (shifting right) due to increasing population, low interest rates, etc. While supply is not able to keep pace, the result being a series of price increases due to excess demand.

At least that is the story which seems to make the most sense looking at the current situation. The question is what is actually happening? Is the demand for housing outpacing the ability to supply new units?

to take a look at this I pulled the following data sets:

• BC annual population estimates.
• BC residential housing starts, all unit types.

to keep consistency between the two data sets, I only focus on the common years from 1999 to 2016.

Comparing the annual estimated increase to BC's population with residential starts we see the following:

here we see what we would expect, given the price situation, the population has outpaced new housing starts for almost the entire 17 years under evaluation.

But this is where we need to be careful, not everyone needs a house! most people tend to live with a few others all at the same residence. According to the latest census, the Canadian and BC average household size is 2.5 people, so if we take this into account we have a very different story.

Now we see almost the opposite case. With the exception of 2009, every year residential housing starts outpaced household formation. This is saying that supply has outpaced demand!

If this is the case we have excess supply and we should have been seeing house prices dropping across BC for the last 17 years, not increasing! This does not seem right, let's go back to what we know, in order to figure out what is happening.

1. Prices have been drastically increasing across BC for the last 17 years.
2. Housing starts have outpaced household formation.

For prices to be increasing, we must have either (a) demand growing faster than supply, or (b) supply shrinking. Clearly, supply has not been shrinking so something must have been missed in the demand. 

Arguably the excess demand is coming from the use of real estate as an investment over shelter (probably not a shocker to most!). that is if these properties are being purchased with the hope to "flip" them once they have appreciated enough in value, then we have our missing demand. 

While this may make sense ... the number here seems extraordinary! take a look at the proportion of housing starts to household formation:

On average (gray line) there have been 1.8 units built for every household formed. If these excess starts over household formations were captured by investors purchasing units, then price should have remained stable (growth of demand roughly equal to the growth of supply). What we have seen instead is skyrocketing prices, implying that there has been greater demand for residential units than have been supplied over these 17 years.

So where on average, 1.8 units have been built for every household formed (almost 2 units per household!) investment demand for units must have been even greater, perhaps in the realm that for every unit purchased due to a household being formed, another 1 to 1.5 was purchased for investment, not for shelter. 

I would love to see some data on vacant houses ... as 60 to 65% of BC lives between the CRD, Vancouver or Lower Mainland, I am a bit skeptical that there would be almost a vacant investment unit for every unit occupied! but maybe I am not looking.

If this is the case, then vacant investment properties are the cause for skyrocketing house prices, why isn't more done to restrict this? 

1. Anyone who owned a house is more than happy to see their equity skyrocket and would be furious to see it collapse now.
2. Anyone who has recently bought a house at this high price would be devastated if their house price collapsed.
3. The FIRE (Finance, Insurance, Real Estate) industry is the driver of the BC economy. See here among other sources.

With all this in mind - Yes the new downpayment policy will further spur demand, creating an even greater upward pressure on prices. From the liberals' view, this will give the economy a little short-run kick, fueling the FIRE industry, and hopefully making everything look rosy so that we are all happy for election time.

What are your thoughts? good policy? just politics? anyone planning to take advantage of the loan?  anyone have any insight into investment purchases, I would love to see some data from that side to compare.