A fascinating trend from an economic perspective is the growing popularity among consumers to purchase a second home. Whether it is being used as a vacation cottage, it is rented out or is merely an alternative to one’s primary address, the purchase of a second home is typically viewed as a Status Good. Additionally, this trend runs exactly opposite to the Theory of Marginal Utility and it thus makes the discipline of Real Estate the great exception to the general rule.
In every society, from the Marxist to the Capitalist, there is a fairly sizeable minority class which always has a surplus of cash from income or an ability to borrow sufficient for its expenditure to have stimulative effects on the general economy. Whereas in past historical times this minority class consisted mainly of the royalty and the aristocracy, it now comprises something like 25 percent to 30 percent of the population of a developed country. Because the education system in advanced countries is as egalitarian and selective as it has ever been in history, and because the skill requirements of a modern advanced economy are higher than ever before, this minority class tends to be clearly divided from the remainder of the population in terms of intelligence, educational attainments and cultural tastes
With extra spendable resources at its disposal and a fairly higher degree of education, knowledge and experience, it comes to a point where this minority class focuses its energies and resources to the acquisition, holding, perusing, renting and reselling of consumer items which are out of reach of the remainder of the population at large. As such, these items have a distinctive connotation denoting a higher status within society - if none other than in the minds of the beholders, and are called Status Goods. A second or subsequent home is possibly the crown jewel of all consumer goods and the quintessential status symbol.
More specifically, a Status Good is a purchasable item which becomes fashionable enough to have an effect on consumer spending, sufficient to produce a significant boost to the general economy of a nation, or a region, or a culture. The main motivation driving its purchase and use is that of denoting high status in society. Because of its desirability the price of a Status Good is able to carry a high profit margin and thus new providers enter the scene quite quickly with competitively high prices. This explains the recent development of resorts areas throughout the world. Here in British Columbia, for example, Whistler is already a world renown ski resort and site of the 2010 Winter Olympics. The real estate development of Whistler and Blackcomb Mountain in this past decade has seen land prices multiply exponentially from an average of CAD $75,000 in 1995 for a standard residential lot to CAD $750,000 in 2005 for the same lot. Anyone who owns an interest in land in Whistler these days definitely fits the foregoing definition and profile of status consumer.
As stated before, the purchase of a second or subsequent home runs exactly opposite to the Theory of Marginal Utility. “Marginalism” is the economic line of thought that postulates the notion that what is most important for decision-making and to determine economic value is the marginal or last unit of consumption or production. For example, one automobile is very useful for getting around. An additional automobile might be useful in case the first is being repaired, or for spare parts, but it is not as useful as the first. A third automobile has even less utility than the first two. Given the price of cars, one would not expect many people to own three cars because the benefit they receive on the third car would be unlikely to exceed the price. In essence, “marginal utility” is the additional benefit that a consumer derives on an additional unit of a commodity output. Such additional output is said to have economic value if the additional benefit exceeds the price of the output. The concept grew out of attempts by 19th-century economists to explain the fundamental economic reality of price.
As it relates to real estate, therefore, the usefulness of a second or subsequent home should diminish and, in accordance to the Theory, so should its price, so that second or subsequent homes should not possess economic value and, thus, demand for them should be minimal to none. Clearly, this is not the case in that real estate is not viewed as a disposable commodity but, rather, it is perceived as an appreciation-generating vehicle - a real capital asset. As proven empirically, second homes as Status Goods are a vital component of consumerism, in that they stimulate demand and production and, thus, economic growth.
Luigi Frascati
Luigi Frascati is a Real Estate Agent based in Vancouver, British Columbia. He holds a Bachelor Degree in Economics and maintains a weblog entitled the Real Estate Chronicle at http://wwwrealestatechronicle.blogspot.com where you can find the full collection of his articles. Luigi is associated with the Sutton Group, the largest real estate organization in Canada, and is based with Sutton-Centre Realty in Burnaby, BC.
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Tags: economics, holding, home trends, investment, marginalism, real estate
Money is the source of all evils - so goes the popular saying. Money is also what makes real estate spin around. So the critical question of the year becomes: where are real estate prices headed? Short of using a crystal ball, there are indeed a few considerations that can be made to have a general idea as to whether prices will continue to surge - at the average rate of 15 percent a year for the past four years - or, alternatively, if we are poised for a shift in the market.
Record-low mortgages, pent-up demand and improving consumer confidence have made this the fourth consecutive best year for home and condo sales in the Greater Vancouver area. The sales-to-active listings ratio, defined as the number of sales at any given time relative and directly in function of the number of inventory listings available at the same time, is over 30 percent compared to about 20 percent in a balanced market. If we want to be even more technical, price increases have been rising at about 7 to 8 times the national inflation rate, a sure sign that demand has consistently exceeded supply which, in turn, has made real estate a Seller’s market for the most part of the past four years.
And the consequence of this all, albeit you may not have directly noticed, is that Canadians are getting richer because of built-up equity. You bought a condo, for instance, in 2003 for CAD $150,000 using a $100,000 mortgage at 4.5 percent interest calculated semi-annually, not in advance. Your condo is worth, today, $195,000 in 2005 Dollars. Your loan has now diminished to an outstanding balance of approximately $97,770 so that, therefore, you have acquired a built-in equity of CAD $97,230. Since you initially invested CAD $50,000 of your own money, your return has been $47,230 in two years or a hefty 47.23 percent per year. Not too shabby. That sure beats the stock market.
Will you be making another 47.23 percent at the end of 2006 ?
You probably will, unless certain economic forces will conjure up against you. These forces - or variables as they are known in economics - are: energy cost, interest rates and affordability. Now, here there are a few clouds looming on the horizon that may make the future look somewhat different from the past.
Energy costs are on the rise. And Hurricane Katrina and Hurricane Rita and the hurricanes that will come afterwards do not help. To be sure, energy prices were on the rise even before the hurricanes that have devastated the Gulf region came around. In fact, most economists still predict no overall long-lasting impact from Katrina. Yet, the same economists also predict that energy costs will not come down to pre-2004 levels. The rises are here to stay, and that applies to all motor vehicle fuels, natural gas, electricity. Everything that affects our capitalistic economies, and not solely in North America.
Prices of consumer goods, henceforth, are on the rise as well because it is costing more to produce and to ship them all around. Each and every house component is bound to cost more as well. And the people that are in the process today of building your future dream home or your next real estate investment … they too will have to pay more to go to the work site. And, taken globally, a rise in manufacturing and shipping costs typically translates in an overall currency devaluation, a noble way to avoid mentioning the infamous i-word: inflation.
Fed Chairman Alan Greenspan - Mr. Monetarist as some affectionately call him - has been saying this all along this past year. Except that nobody wanted to listen. Reality was much rosier than the somewhat gloomy outlook offered by the venerable Chairman. And the Fed has been keeping the steady course of raising interest rates, albeit not hurriedly or in a draconian fashion. And they continue to hold this course.
Which, then, brings us to the third variable: affordability. Let’s take a look back at the initial example of you buying a condo in 2003 for $150,000 with $50,000 of your own money. Ask yourself this question: could you, today, buy the same condo for $195,000 with the same $50,000 downpayment ? If you are like the majority of real estate consumers, the answer is probably no. You would need a $145,000 mortgage today as opposed to the $100,000 mortgage you took in 2003. Which means you would have to show your lender that your gross income has increased of $15,000 per year - which probably has not. Bankers say they cannot lower their qualifications standards as they are working on the bare minimum (I still have to meet a banker dying of starvation, but …). Which, therefore, leads to the conclusion that you would not qualify today for the mortgage. Such being the case, you would no longer be what we in real estate call a ‘market participant’ . And if a lot of people are or will find themselves into the same situation, the end result will be a lower demand.
So, therefore, what’s the verdict? Are prices going to continue to surge or are we heading for Apocalypse Now? Probably neither. But if the foregoing models hold true, it is reasonable to expect a slowdown in appreciation of property values - which in turn implies a correction in prices. Those of us who are involved into real estate on a professional level are beginning to see this already: asking prices are somewhat shifting down, although asking prices are not really reflective of market trends due to their very subjective nature. And it must also be noted that a shift downwards in asking prices is a far cry from the dreaded real estate bubble some people have been prognosticating all along. But it looks more and more that the market is due for an adjustment.
Luigi Frascati is a Real Estate Agent based in Vancouver, British Columbia. He holds a Bachelor Degree in Economics and maintains a weblog entitled the Real Estate Chronicle at http://wwwrealestatechronicle.blogspot.com where you can find the full collection of his articles. Luigi is associated with the Sutton Group, the largest real estate organization in Canada, and is based with Sutton-Centre Realty in Burnaby, BC.
Tags: economics, finance, investment, real estate, real estate bubble, real estate prices