The old sentiment of “Your head may be in a freezer and your feet in an over, but on average you are fine” is obviously wrong.
If it is so obvious in this context, why are so many people influenced by ‘Average’ prices, ‘Average’ rents and ‘Average’ economic growth? To a strategic investor, basing decisions on ‘average’ numbers is just like developing a medical diagnosis based on the above old sentiment. FOOLISH and incredibly dangerous.
We live in a world of headlines that pump national average house price, average number of housing starts, and the average household debt. The most important thing to remember about all these average numbers is that they don’t mean much in the grand scheme of things.
When it comes to investing in real estate, an average house price is the equivalent of taking the average temperature of every patient in a hospital, determining that it works out to 98.6 degrees and making the statement that everyone is in good health – it’s just not accurate. ‘Secrets of the Canadian Real Estate Cycle‘ will give you the insight you need to do the digging and look beyond the ‘average’ headlines.
Here is part 4 of the ‘Secrets of the Canadian Real Estate Cycle‘ blog series. It will help debunk some myths as well as assist you in focusing on what really matters when looking at the stats for your target area. I urge you to follow the links throughout it for further information and detail.
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Measuring Real Estate Values: Averages Don’t Matter
Another area of confusion with real estate statistics concerns the way values are measured. Real estate values are measured in various ways throughout the world, including by averages, medians and varying forms of indexes. Some of these measurements produce an inaccurate indication of what is actually happening to real estate values.
It is surprising how often less reliable data, such as averages or median sales prices, are quoted as a representation of what’s happening in a real estate market. These figures can easily present a distorted view. For example, when there is a disproportionately high level of sales activity of superior real estate in an area in a given period, it may appear that values in that area are increasing purely because the average and/or median price will look higher than it had previously. Prices for such “superior” real estate may have actually decreased, but this may not be represented by the average or median figures.
Conversely, such a period may be followed by a high level of sales activity of inferior or lower-priced real estate in the same area. That may seem to indicate that values in the area are decreasing purely because the average and median sales prices are lower. In reality, that period may have been characterized by a few sales of superior real estate, so while the average and median figures indicate that values are declining, they may actually be increasing.
To obtain more accurate information on real estate value trends, we suggest using one of two methods.
1. Indexes: Indexes that are calculated from repeat sales of similar single-family homes, such as the S&P/Case-Shiller Home Price Indices used in the United States, are considered by many economists to be a more accurate way to represent a market’s overall real estate values. Until 2008, Canada was without a nationally recognized house price index. Fortunately, Teranet, in alliance with the National Bank of Canada, created an index that dates back to 1999 for the metropolitan areas of Vancouver, Calgary, Toronto, Ottawa, Montreal and Halifax. Here is a direct link to the Teranet Housing Price Index
2. Moving Average: Using the average Multiple Listing Service (MLS) prices reported monthly, economists calculate and trend the 12-month moving average. The 12-month moving average helps normalize the data and remove the month-to-month volatility described above.
3. “Average Rents” One of the most misused, and frankly, financially dangerous numbers that the non-strategic investor uses is the average rent number for their area. I have seen investors make decisions on what to set their rental rate at. WOW, could this not be the worst case of bad management. When you see average rents, they are usually created from an small survey done by CHMC for a region. The numbers may be true for that snapshot in time, which is usually a few months prior to the release, but in a landlord or tenant’s eye this number means nothing.
What matters is “What will the market pay for this rental property TODAY?” To answer that question a landlord must take a survey of what is for rent in that neighbourhood and type of property in the moment it is ready to rent. That means they must do a little work themselves. Jumping on the internet and playing the role of a potential renter will help the landlord discover what the competition looks like at that moment. Type in the phrases that a potential renter would use in popular search engines (ie Suite For Rent Hamilton), then see what’s out there.
Another resource is Padmapper.com which takes all of the free sites (ie Craigslist, Kijjiji) and puts all of the current listing on a map of your neighbourhood. A great tool when deciding what your rent should be. DO NOT USE AVERAGES or you could be leaving a lot of monthly cashflow on the table.
Chapter Summary – Put the Cycle Secrets to Work
The real estate cycle is an irregular but recurrent and predictable succession of causes and effects that the real estate market experiences with resultant impacts on the creation and destruction of real estate wealth.
The cycle moves through three phases: boom, slump and recovery. Market influencers may contribute to its progress, or to temporary aberrations. Key drivers, on the other hand, always propel the cycle forward through predictable patterns. The duration of the phases changes depending on key drivers.
Efforts to interpret point-in-time statistics during any phase of the real estate cycle are complicated by a lack of context. The end result is statistics with little meaning, resulting in confusion. Strategic investors in pursuit of reality avoid this confusion by using key drivers to track the real estate cycle. They know the cycle is predictable in terms of its progress, and unpredictable in terms of its duration. That does not distract them from informed action based on what the key drivers tell them to do.
Click here for Part One.
Click here for Part Two.
Click here for Part Three.
Secrets of the Canadian Real Estate Cycle will give you insight into the economic fundamentals that you may not have realized before. Make sure to look out for the next post in this series, coming out next week. Good luck and happy investing!