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Huge impact of renos on home prices goes undetected

In the first two parts of [a series from John Melinte, an Associate of the Society of Actuaries] it was established that the return on investment in real estate is not nearly as great as you think and second, we do have an affordability problem.

Here’s our third major finding based on our analysis of that data (note that this is only for the detached and semi-detached segments of the market – it does not include condos or townhouses), that the level of home reno activity is a a significant contributor to the price of homes.

  • Of the 1,000 “re-sold” houses, only 26 of them were sold for less than they were purchased (these were probably foreclosures, distressed sales, or has issues / damages that were discovered after the first purchase).
  • On average, the “holding” period for these houses was 1.4 years, with a weighted-average price increase of 53% during that period (or 36% per year).
  • Smaller & cheaper houses increased in value faster than bigger more expensive houses.
  • After adjusting for transaction fees, net average returns were still 30% per year.

But how much of this was caused by “value added” activity? Well, it turned out there was way more than we expected. We determined that at least HALF of the houses in the 1,000 house data set had been significantly renovated or completely rebuilt. We removed these houses from the data so we could analyze only the “apples to apples” houses (that is, houses that were bought and then sold again without significant renovations). Below are some key metrics for the “apples to apples” houses:

  • The average “holding” period was a bit shorter at 1.2 years (which makes sense, since they did not need extra time to have significant work done).
  • These houses showed average net returns of only 9.5% per year (compared to 30% per year for the entire group!).

This implied to us that many people were not buying the same house that was bought by the current owners. They were buying a house that had hundreds of thousands (and in some cases, millions) of dollars invested in it.

This has been an eye-opening exercise for us and our analysis has resulted in the following conclusions:

  1. Prices have been materially impacted by lower interest rates. What can we do about this? Not much, it turns out (at least not right away) – interest rates are a tricky beast because they impact all aspects of our economy, and the federal government is very hesitant to increase them at any speed faster than a snail’s pace.
  1. The impact of “value-added” activity, which has been sorely left out of any mainstream media analysis, is a significant contributor to price increases and general unaffordability. What can we do about this? Well, I suppose the city could implement a moratorium on major residential renovations (or maybe a higher tax on “flipped” house sales). This would increase the supply of smaller, older (cheaper) houses.
  1. Foreign buyer taxes may cause a temporary decrease in home prices (as we have seen in other cities), but the data does not point to foreign buyers as a major factor in these recent price hikes. Unfortunately, these are the issues our government has decided to focus on (perhaps because they are easier to deal with), while ignoring the real issues.

In the long-term, I believe housing prices will be tempered by other more general technological and societal advances. For example, working remotely continues to grow in popularity with forward-thinking companies. Advances in transportation technology will reduce traffic and increase efficiency (think inter-connected driver-less ubers all moving in perfect sync). Eventually, many of the jobs that require a physical presence will not. Furthermore, developments in energy technology will allow people to live efficiently and comfortably “off the grid”. Canada has plenty of space and over time society’s focus will shift from where we live to how we live.

John Melinte is an Associate of the Society of Actuaries and a partner at a leading corporate housing firm in Toronto.


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