Real estate markets are subject to cyclical ebbs and flows. Additional black swan events such as the invasion of Ukraine by Russia and the far-reaching consequences of the war have a pronounced effect on global capital markets and interest rates.
Naturally, the real estate market in Vancouver was not immune to this shock. Inflationary pressures created by the prospect of prolonged conflict in Europe and the continued disruption of supply chains from COVID-19 have caused enormous uncertainty in the cost of construction.
Supply Chain Disruption and the Real Estate Market
The real estate market was dealt a second blow as the central banks declared war on inflation and raised rates in Q2 2022 at a ferocious and unprecedented rate. As a result, the terminal rate of interest is still unclear. Investors and developers who already struggle to mitigate the construction cost risk now have to mitigate and predict where the interest rate might lie in the future.
Facing the two unpredictable risk factors of construction cost inflation and interest rate hikes while being unable to accurately predict risk and returns, investors have exited markets across all asset classes and liquidity has all but dried up. Real Estate markets are inherently less liquid than other asset classes and in periods of low liquidity, real estate assets, particularly development land, are more susceptible to price overcorrection.
The result is a divergence between the intrinsic value of assets and the price the low-buyer market is willing to bear. These are the periods in which sophisticated real estate investors enter the market and take advantage of distressed assets to find opportunities for outsized returns. These investors are fully aware that over the medium to long term, the real estate market will revert to the mean. Unless under duress, liquidating a position in these markets will usually mean the full value of the asset is not realized.