The Multiple Offer Trap

When offering real estate for sale, some brokers will suggest to clients that they set a low selling price, open the property for showings for a short time, then set one day for offers. The brokers are attempting to create multiple offers which they think will result in a price higher than market. The broker is trying to simulate a silent auction where bid prices are not known. Staging a property for multiple offers is very risky to everyone except the real estate agents involved. We advise against ever being involved in a potential multiple offer situation, either as a buyer or a seller, especially for a principal residence.

As a seller, one risk is that all the offers you receive will be above your list price, but below the price you expected to sell your property. You do have the choice to decline all offers (provided they all had conditions), but then are faced with having to re-launch the sale of your property. This can be a big issue if you have committed to purchasing a new property, but not included the sale of the existing property as a condition. There is also the risk that you get only one offer, but that one is at, or only slightly above, your list price. If that offer comes with no conditions, Canadian contract law technically requires that you accept the offer. I have never known a real estate agent to explain this risk to sellers. An additional risk is that regularly buying and then selling property using a multiple offer process could be deemed by the Canadian Revenue Agency (CRA) as a business and result in taxes being paid on the difference between the list price and the selling price.

As a buyer, there are many risks associated with multiple offer situations. In one situation, buyers, desperate for a specific property, bid 15% higher than the list price. They won the bid, but their bank, after getting an appraisal well below the bid price, declined the pre-approved financing. The buyer was placed in a situation where they had to forfeit a $10,000 deposit in order to get out of the sales contract. In another situation, the bid was successful, and the financing squeaked through, but a number of other costs such as land transfer tax, which is based on a % of selling price, proved too burdensome and the deal fell through. Most concerning was a client of ours that became involved in a multiple offer situation where the other prospective buyers turned out to be shadow numbered corporations of the seller! The broker who represented the seller advised that if we had concerns to complain to the real estate association. We knew that was a waste of time. Instead we swore out a criminal complaint against the seller and their agent. There are also insurance coverage issues that come into play. We are not insurance experts so we advise anyone who goes into a multiple auction sale to discuss insurance issues with their insurance advisor.

There is one situation where we advise that it might be ok to be involved with multiple offers. That situation is where there is a legitimate open auction, and all bids are known by all bidders. And only where conditions with respect to pre and post auction inspection and disclosure are accepted. Even then, there are still risks especially if a property is not fully completed or there are disputes about the actual definition of the property.

If a client insists that they want to offer in a multiple offer situation then we recommend this approach:

Put the offer in a sealed envelope and deliver the envelope with a contractual letter attached that reads - "opening the offer envelop will cost the seller $20,000, an amount to be waived in the event that the offer is accepted. " This approach is standard in other businesses where multiple offers are used.

Where Did the Market Go?

The Pacific Coast of British Columbia, in particular the lower mainland, is the riskiest market in Canada to invest in housing.

Price risk is systemic in the market, with unpredictable short term, real price increases always followed by long term (more than 8 years), real price declines, or, at best, nominal increases. For example, after more than a 100% increase in prices from 1979-1981, real prices dropped so much and for so long that they needed until 2002 - 2004 to surpass the 1981 high. A 1995 buyer did not see a real price increase until 2005. Price disclosure is clouded by the fact the local real estate board regularly issues inconsistent reports. For instance, in July this year, the Vancouver board reported locally that prices in Vancouver were up about 5% year-after-year but reported a different set of numbers to national real estate association which showed a 1% year-after-year decline.

Construction risk in this market is the highest in Canada. The leaky condo crisis of the late 1990s resulted in the collapse of the BC New Home Warranty Program, something unparalleled in Canada. While the crisis may seem to be over, many condos/strata still do not comply with rainscreen standards. The costs to buyers of resale condos/strata can range from $30M to $200M in repairs. We consider legislative requirements for reserve funds to be inadequate given the risk. Building code and municipal by-laws/standards are weak compared to Ontario and Quebec standards. For instance, owners of wood framed condos/strata are not prohibited from having propane equipment on their exterior decks, with the result that wood frame buildings suffer extreme damage from source-localized fires. Sprinkler systems are required, but we are well aware that sprinkler systems reduce insurance claims for infrastructure rebuilding but have no virtually impact on individual owner, non-structural property replacement such as furniture.

This risky market is now in decline. A plummet would be best how to describe it. Sales are off almost 50% year-over-year in Vancouver. Prices are down, drastically in some cases, but price declines are difficult to track because of the way prices are reported.

In many local areas, prices have no-where to go but down, and far down. There are some condos in signature buildings, such as the Shangri-La and Ritz Carlton, listing from $12-29 million. We have seen such condos, in other markets, marked down by 60-70% in order to sell them. And we have watched near identical projects, such as the proposed Toronto Ritz Carlton, fail. In addition, the business model of mixed use condo/hotel/commercial buildings is fraught with problems (Tower 3 of the Peninsula development in Puerto Vallarta, and 1 King West in Toronto are examples) and seldom meet cash flow projections. The Coal Harbour area of Vancouver boasts an average price of over $800M for condos. These condos rent for $2,000 to $4,000 per month, which means that on a cash flow basis, they are worth between $240M to $480M depending on assumed interest rates.

How bad will it get here. We projected a 25% decline in price in this market. We now consider that number to be very conservative. We are now projecting a 25-30% decline in prices depending on neighborhood and property type. Single family homes in good locations such as West Vancouver and North Vancouver are best protected from price declines. Expensive, large-square-foot, cookie-cutter, high rise condos in such areas as Yaletown and Coal Harbour, or in suburban locations, are at the greatest risk of 30%+ price declines.

In case these projections seem pessimistic we can provide the following proven historical price declines from other markets:

Hong Kong real estate 1997-2001 - down 60% in price

Toronto real estate April, 1989 - October, 1996 - down 35%

Panama City, Florida Condo prices April 2006 - April, 2008 - down 33%

Mt. Tremblant real estate April 2003 - August 2008 - down 25%

Any recommendations we make depend on a buyer/investor's individual circumstances. However, we do recommend that anyone considering selling in this market in the next 4 years, do so now. We would be hesitant to issue any buy recommendations, again dependent on specific circumstances and objectives.

Variations in Price Create Considerable Risk

Over the past 28 years, within Canadian cities, and between large Canadian cities, property prices have fluctuated greatly. Today, for instance, Vancouver's average home is about $500,000, while Toronto is $400,000 and Ottawa just shy of $300,000. It wasn't long ago that all three cities had virtually identical home prices.

In 1980 in Vancouver, prices shot up by about 100%, only to fall by 40% in the next year. Edmonton experienced a similar profile. Between 1985 and 1989 in Toronto, prices rose by nearly 180%, only to drop by 35% over the next 7 years. These large fluctuations in price were unheard of prior to the baby boom entering the housing market. The average price for a property in Ottawa and Vancouver were near identical from the time statistics were kept until that explosion in Vancouver prices in 1980. Ottawa, Montreal and Toronto had near identical house prices of $29,000 in 1969, and those remained near identical at $107,000 in 1985. But four years later, Toronto prices reached $280,000, Ottawa $140,000 and Montreal just $125,000.

Canada's housing market was very stable from the end of World War II until the spectre of inflation and the first oil crisis in 1972, neither which were on the radar of most economists just two years earlier in 1970. Prices advanced almost yearly after WWII but only in the mid single digits. Most Canadian cities continued to be very similarly priced. For the next few years after 1972, prices increased more rapidly, but remained similar across most markets. It was in Western Canada in 1980 that everything started to change. Purchase price risk had now been introduced into the Canadian housing market, particularly for first time buyers, people moving from one city to another and second home buyers.

The last eight years have been very good for the Canadian housing market, primarily as a result of the lowest mortgage rates since the 1960s, again something that no economists had on their radar screens when we were all scrambling to capture that Y2K bug in the late 1990s or when the teck bubble went burst in 2000.

With the exception of an environment of lowered mortgage rates, it is virtually impossible to predict the direction and magnitude of housing price changes. The reasons for this are that housing prices seem most dependent on shocks, both positive and negative, to the system, that did not exist in the prediction model. In the past 4 years in Canada, house prices in Alberta have shot up faster than anywhere else in the country, as a result of a booming oil-based economy driven by $140 barrel oil, something no-one thought possible in 2004.

So when is a good time to buy a house. That answer has traditionally depended on local market conditions and what you can afford. However, given the need to now manage the large fluctuations in Canadian house prices, particularly for anyone that is moving from one city to the next, house purchases should only be considered after a thorough financial review. That review must consider: your financial objectives, your overall financial profile including possible career transfers or retirement plans, and at what stage in life you are in.

Real estate agents tend to be experts on market conditions and mortgage lenders can provide assistance determining what you can afford.

But you can only rely on independent advice regarding objectives, financial profile and stage in life from an independent financial consultant. That consultant should also be focused on wealth creation and protection, as well as risk management, all of which have become much more important given the fluctuations of price in the Canadian housing market.

Home Equity Loans Can Be Cheaper

Using equity in a home for investments, purchase of a second home, vacations etc. has become commonplace.

If you have an existing home equity line of credit, it may appear to be a simple way to borrow.

And it is simple, but tax-inefficient and very expensive.

There are ways to structure a home equity loan so that interest payments are tax deductible, and so that you only pay interest on the money you are immediately using rather than paying interest on the entire home equity loan.

Someone who takes out $200,000 from their home equity line of credit can pay as much as $14,000 per year in interest. But with proper financial structure, that interest can be reduced to only $3,000 per year.

Your banker will generally not explain how to reduce your interest payments since that reduces their income. And your real estate agent is not qualified to explain how to take advantage of home equity lending options. Rely on a fee based financial consultant to assist you.

Prices, Sales Drop, Inventory Increases

Summer Arrives on the West Coast

Kitts Beach in Vancouver was busy last week as people took advantage of record high temperatures to catch some sun. By the weekend, temperatures had returned to normal.

And after a record setting eight year expansion, by all metrics, Greater Vancouver's real estate market has also returned to normal.

The region saw 2,425 sales registered through the Multiple Listing Service in June, a 43-per-cent decline from the same month a year ago.

At the same time, owners listed 6,546 properties, an 18 per cent increase from the same month a year ago.

At June 30, Greater Vancouver's inventory of unsold properties stood at 18,260, a 54-per-cent increase from a year ago. That is nine months of inventory, a key indicator of a buyer's market and a harbinger of declining prices.

June's average price dropped from May, a trend that started in March. Prices are up about 6% year-over-year.

With the flattening of the real estate market along both the West Coast and all of Canada, real estate joins a number of other investment categories showing little or no opportunities. Mutual funds, the equity markets and fixed income markets are all weak. The only growth appears to be in select commodities, a market which is highly specialized and not-at-all for the average investor.

Any recommendations we make are general in nature only, and specific investor objectives and circumstances will impact recommendations. In general, this is a very good time for real estate investors to consolidate their positions and remain liquid by holding assets easily converted to cash, as well as having lines-of-credit pre-approved. Investors who know they have to sell real estate on the West Coast in the next 2-4 years should sell now.

The Lower Mainland Real Estate Market

Spring in Vancouver, British Columbia

Spring arrives in British Columbia earlier than it does in the rest of Canada. The cherry trees have been in full blossom for two weeks, the tulips all red, yellow and purple for three weeks.

A slow real estate market here has also arrived this spring. Real estate sales were down 14% for the first three months of the year, a trend that gained momentum into April. Listings, at an all time high, were up 25% year-over-year.

Prices in Vancouver, although up year-over-year, are down about 10% from their highs earlier this year, a much steeper decline than expected. The decline appears to be a trend which has accelerated since the first week of March.

This is not a good time for home sellers. It is a good time for home buyers. However, they would still be buying near the top of the market. Vancouver and British Columbia real estate prices have historically dropped rapidly after a steep run up. In the early 1980s, prices dropped 40% in just 12 months, after a two-year 100% run up. And a four year run up has just ended.

The fundamentals impacting the investment, retirement and recreational markets are not good. Credit for recreational and investment properties has been tightened, pricing already reflects the 2010 Olympic rental income potential, Americans are staying away in droves, and with real incomes continuing to fall in British Columbia, the supply of available buyers is declining. Although not as overbuilt as some markets, the traditional recreational markets in British Columbia are at risk of becoming speculative. Cash rich Albertans are helping keep the markets going in the short term.

As with all our recommendations, advice must be tailored to the individual investor. However, any investor who knows they will sell in the next two - four years would be wise to sell now, using a lower price as the key selling point. Anyone considering buying, would be wise to wait until after 2011.