Friday, August 26, 2005
Real Estate Market: the Quintessential Business Cycle
The United States, Canada and all other modern industrial economies experience significant swings in economic activity. In some years most industries are booming and unemployment is low; in other years most industries are operating well below capacity and unemployment is high. Periods of economic expansion are typically called booms; periods of economic decline are called recessions or depressions. The combination of booms and recessions, the ebb and flow of economic activity, is called the business cycle. But of all the industries contained in the economic basket of goods, the real estate market is the one that serves as an indicator and prognosticator of times to come.
Real estate is partcularly susceptible to the ups and downs of the economy simply because it is a big ticket industry. The purchase of a single-family dwelling, the sale of a condo, the lease of industrial or office space - all these are transactions involving big dollars. One of the key insights of business cycles is that many economic indicators move together. During a boom, or expansion, not only does output rise, but also employment rises and unemployment falls. New construction and prices typically rise during a boom as well. Conversely, during a downturn, or depression, not only does the output of goods and services decline, but employment falls and unemployment rises as well. New construction also declines but - and real estate is the exception to the rule - prices may very well continue to rise in real estate even during downturns, though usually more slowly than during booms.
In many ways the term business cycle is misleading. "Cycle" seems to imply that there is some regularity in the timing and duration of upswings and downswings in economic activity. This could not be more farther from the truth, especially in the real estate industry. Booms and recessions occur at irregular intervals and last for varying lengths of time. For example, economic activity hit low points in 1975, 1980, and 1982. The 1982 trough was then followed by eight years of uninterrupted expansion. For describing the swings in economic activity, therefore, most modern economists prefer the term 'economic fluctuations'. Just as there is no regularity in the timing of business cycles, there is no reason why cycles have to occur at all. The prevailing view among economists is that there is a level of economic activity, often referred to as full employment, at which the economy theoretically could stay forever. Full employment refers to a level of production at which all the inputs to the production process are being used, but not so intensively that they wear out, break down, or insist on higher wages and more vacations. If nothing disturbs the economy, the full-employment level of output, which naturally tends to grow as the population increases and new technologies are discovered, can be maintained forever. There is no reason why a time of full employment has to give way to either a full-fledged boom or a recession.
Business cycles do occur, however, because there are disturbances to the economy of one sort or another. The quintessential cause of recessions and booms in real estate is monetary policy. The central banks - either the Bank of Canada or the Federal Reserve Bank in the U.S. - determine the size and growth rate of the money stock and, thus, the level of interest rates in the economy. Interest rates, in turn, are a crucial determinant of how much firms and consumers want to spend. A firm faced with high interest rates may decide to postpone building a new factory because the cost of borrowing is so high. Conversely, a consumer may be lured into buying a new home if interest rates are low and mortgage payments are, therefore, more affordable. Thus, by raising or lowering interest rates, the central banks are able to generate recessions or booms. This is the reason why keeping a close eye on interest rates is so crucial in the real estate market.
Luigi Frascati
Real Estate Chronicle
Saturday, August 20, 2005
Stigmatized Properties: Disclosure of Latent Defects
Latent defects are those hidden or concealed defects that would not be discovered in the course of a reasonable inspection. Latent defects are the opposite of patent defects, which by definition are defects plainly visible or that can be discovered in the course of a reasonable inspection. In real estate, although misrepresentation normally requires a statement to be made to the Buyer silence can also result in some liability on the part of the Seller. Prior to entering into a Contract to sell real estate the Seller is required to disclose to the Buyer any latent defects the Seller is aware of. Failure to disclose will not affect the consent of the parties, but will have similar consequences as misrepresentation.
Technically speaking, latent defects are facts that :
1) are unknown to the Buyer and are so crucial to the enjoyment and value of the property that the Buyer might not have entered into the Contract had he known they existed and
2) cannot be discovered upon reasonable inspection of the property.
An example of a latent defect in one case was the presence of an underground water culvert which was not apparent from a normal inspection of the land and which the Seller was aware of and failed to disclose. If the Seller does not disclose the existence of a latent defect, the Buyer can rescind the Contract and/or recover damages. Other more typical examples of latent defects are the existence of urea formaldehyde foam insulation or asbestos insulation in a property offered for sale. However, the Seller will not be held liable for failing to disclose a latent defect he was unaware of unless a reasonable person would have been aware of it.
Some latent defects are out of the ordinary but must still be disclosed if known to the Seller. For instance, properties rumored to be haunted are one such example, as is a property previously used as a site for a marijuana grow operation. In one recent court case, a luxury condominium where someone had committed suicide was held as a property with a latent defect that the Seller had a duty to disclose to the Buyer. These are known as 'stigmatized properties' because they are associated with a 'stigma' , an unusual, distressing event or circumstance such as murder, suicide or criminal activity. These properties may be worth less or could be hard to resell because prospective Buyers might not consider them. As such, the market for stigmatized properties is drastically reduced - and so is their value.
Luigi Frascati
Real Estate Chronicle
Monday, August 01, 2005
Good News for Leaky Condo Homeowners: but Vancouver may be the Exception
A recent visit to a Client of mine has spurred me to write this article. This Client bought an apartment in Burnaby, B.C. in 2001 in a building that was at the time considered leakproof. For a variety of reasons, the building has since then developed a big envelope and rainscreen problem with an overall cost of repairs running in the CAD $8 million figure. After receiving a few estimates Strata Council is now involved in the claims submission to the Homeowners Protection Office (HPO). The average special assessment for each property Owner hovers to on or about CAD $40,000.
The good news is that pursuant to current legislation many of these property Owners need not to worry - at least not to worry so much. Since the BC Supreme Court, back in 2001, found the Municipality of Delta liable to cover the costs associated with repairs to the Riverwest Complex, municipalities throughout the Lower Mainland have been put under the microscope. In the Riverwest action it was alleged negligent approval of the application for a building permit on the part of the Municipality of Delta. The action, furthermore, alleged negligent inspection of construction and negligent issuance of the final occupancy permit. The judge - who ultimately awarded CAD $3.15 million to Riverwest - found the municipality to be partly responsible for water damage because it failed to enforce Part 5 of the BC Building Code. Part 5 states, among other things, that municipalities must be actively involved in the examination of building plans and subsequent inspection of construction. In the Riverwest case, the Judge found that Delta had failed to live up to the word of the Code.
This decision of the Supreme Court has had a tremendous impact throughout the Lower Mainland, where the aggregate estimated cost of repairs to leaky condos exceeds CAD $1 billion. City of Vancouver Owners of water-damaged condominiums, however, may not be able to sue for damages proximately caused by negligence in building inspections and issuance of final occupancy permits on the part of City Hall. In 1987 the Vancouver Charter was amended so as to protect the City from responsibility arising out of claims of negligence from Building Code regulations. The amendment states that Vancouver has "no legal duty" to ensure that plans and construction "comply with the By-laws of the City". The amendment, moreover, goes as far as stating that "the City or any officer or employee is not liable for damages of any nature, including economic loss" relating to the enforcement of building codes.
What has become to be known as the "leaky condo crisis" has now been around for about five years. In 1999/2000 the Provincial Government responded with the Barrett Commission of Inquiry into Condominium Construction. Report recommendations resulted in the creation of the Homeowners Protection Office (HPO), now responsible for residential builders licensing, repair loan programs and a PST relief grant for homeowners of leaky condos. The Homeowner Protection Act was also developed.
Luigi Frascati
Real Estate Chronicle
