The Illegal Drug Trade and High Real Estate Prices

September 1, 2011

THE 1930s-STYLE HOME—a well-maintained, nondescript two-level on West 12th near Trimble—had been owned by a succession of engineers and built to withstand earthquakes. It fit in nicely on the street. Yet three weeks after Betty Yan and her husband took possession, they started tearing the place apart. They had interior walls removed, the fireplace dismantled, and the main staircase redone—twice. They also added a bathroom. On the outside, they landscaped the yard three or four times, redid the front porch, took it down again. It was like minor Hollywood celebrities had invaded West Point Grey.

Joan Bryans was one of many neighbours who thought it weird how much work the family was doing—rumour pegged the renovation at $800,000, almost half the purchase price of $1.776 million. “It was very obvious that it was outrageously unnecessary.” Not everyone felt so strongly. “The house did need a little updating,” recalls the seller, an about-to-retire engineer at the City of Vancouver. “So the only thing I thought was a little funny was that they took so long to renovate.”

In April 2009, news broke that Yan had been found shot dead in her Mercedes in a Richmond parking lot. Stories after her death described her as a ruthless and violent loan shark who, after coming to Canada as a refugee in the late 1980s, connected with the Big Circle Boys gang. The gang had branched out from drug trafficking into many other ventures, legal and illegal. Among its enterprises, according to police: loan-sharking, human smuggling, money and goods counterfeiting, and exporting stolen cars.

Suddenly the costly renovation made a lot more sense: one of the key vehicles for cleaning up illegal money is real estate. There are dozens of ways to launder money in real estate, from paying cash for down payments or renovations to buying houses in the names of dummy owners to establishing elaborate mortgage-repayment schemes that convert bags of dirty cash into legitimate-seeming transactions. Has the practice become so common in Vancouver it’s helping to drive up real-estate prices? You could hardly blame Betty Yan’s neighbours for thinking so.

Cam Hui was stunned when he moved back to his hometown after a stint on the East coast. “This city is not overrun with the super-rich,” he says. “But you can’t get into the Vancouver West Side for less than $1.5 million for something that’s not falling down.” In Stamford, Connecticut, where Hui, an investment counsellor, lived previously, prices were just as high. But there it was understandable. The place was infested with people working in the investment business. Stamford has the head office of GE Capital, and, with Swiss bank UBS, the world’s largest trading floor.

Hui doesn’t see that level of financial activity here; nor does he buy the standard explanation for Vancouver’s real-estate prices: that offshore investment or Asian money is largely responsible. In a private blog, he argues that there has to be a connection to the drug industry. “And just putting my economist’s hat on, if it winds up back in the local economy, it creates inflation.” He, by the way, has not bought here because Vancouver’s market is so crazy. He rents instead.

Is Hui (along with thousands of other deeply suspicious Vancouverites) right about the province’s booming drug economy and its impact on the housing market? It’s complicated; housing is built from complex pieces of machinery. Even a casual read through the archives of publications like Land Economics and The Journal of Economic Geography exposes a mind-jangling array of Beautiful Mind-type math calculations attempting to tease out the links between a city’s employment rate, attractiveness, median income, land availability, and housing prices.

Are there enough drug dealers and grow ops here to boost the real-estate market? The answer to that is also complicated. Think about it: you’d need a critical mass bidding up the market. In the last two years, an influx of mainland Chinese buyers in Richmond and on the West Side has helped push up prices there compared to the rest of the region. There were 3,300 single-family house sales in Richmond in those two years, and about 7,000 in Vancouver, around half on the West Side. It took a pool of buyers for 6,800 houses to drive prices up noticeably just in those two small areas. (In Salmon Arm, B.C., grow ops became so numerous that land values started climbing when a mere 100 people bought about 30 properties for their drug businesses. And in Woodbridge, Ontario, seven mobsters bought on the same street, inflating values as part of an elaborate fraud.)

Does B.C.’s drug industry even produce enough wealthy people to manipulate the market? First, you’d have to know how big the drug industry really is in the province. The most thorough study of the marijuana industry, done by Stephen Easton at the Fraser Institute in 2004, estimated that our grow ops, numbering around 17,500, generate close to $2 billion in export value per year at wholesale prices; at retail, estimate $7 billion. Assuming (optimistically) Canadian middlemen get all the markup, that makes the marijuana industry about the same size as the forest industry. The $4-billion figure commonly cited seems more likely.

Then there are the drugs brought into B.C., like heroin and cocaine. One 2000 U.S. government estimate of total American spending on illegal drugs besides marijuana was $54 billion. Assuming that grew by 20 percent over the next decade, it would be $60 billion today. If Canada’s number is one-tenth—the general rule for economic stats—that’s $6 billion. B.C. usually accounts for at least one-tenth of national statistics, but with the heavy drug use here, assume we make up 20 percent of the market. That’s $1.2 billion in local sales (less wholesale costs and shipping). This is all tax-free, of course, which boosts buying power.

So let’s say the illegal drug market has the equivalent clout of double its retail sales: $16.4 billion. That’s still just a fraction of our economy (B.C.’s GDP is estimated at $196 billion this year).

How many people end up making enough money from illegal drugs to start bidding up real estate? As American studies beloved by Freakonomics author Steven Levitt have shown, many small-time and mid-level dealers don’t actually make much money. The average wage for grunt-level dealers in one Chicago sample was $700 a month, which is why many of them live in their mother’s basements. And among those mid-level and above, a lot of the money is not, as they say, wisely invested. Expensive cars and nightclubs trump mortgages.

Which leaves the high rollers. Tsur Somerville, the lanky, outspoken UBC professor who scrutinizes local real estate, thinks they do impact the market, but no more than any other growth sector. “It’s just another industry with wealth,” Somerville says. “The fact that it’s drug money makes it no different from the mining industry or any other.” Except for its resilience: the drug industry shows none of the ups and downs that bedevil the mining, gas, and petroleum industries ($9 billion in bad years, $16 billion in good), the financial services industry ($35 billion), or tourism ($7 billion).

Peter Lamey, of Canada’s official money-laundering watchdog, fintrac, thinks drug money does affect local real estate. “If you establish that it’s a multibillion-dollar industry, then inevitably it will have consequences in other parts of the marketplace.” And, as fintrac notes, real estate is a preferred vehicle for parking illegal money, once it’s been washed through structuring (breaking up large amounts into small ones that can more easily be transferred without suspicion) and layering (creating levels of companies, banks, and people that the money moves through).

Duffel bags stuffed with cash used to be a reality, and dumb launderers do still sometimes go to realtors, cash in hand. Even Marty Pospischil, a straight-arrow, West Side agent who keep tabs on prospective purchasers through a large database, had an experience like that. “A fellow from Mexico and his assistant” showed up in the office for an appointment; when Pospischil started discussing possible prices and down payments, the man opened a suitcase and said, “I want to start with this.”

“The ones new to the game, they’ll do that,” agrees Lamey. But things have become tougher since fintrac started requiring realtors and developers of projects larger than four units to report suspicious or large cash transactions, two years ago. In fact, realtors now have to fill out a fintrac form and get identification from anyone who buys real estate anywhere in Canada. That hasn’t generated a huge number of mystery cases. Only 56 real-estate transactions for all of Canada were reported last year. The highest number in B.C. was 16, two years ago, and the numbers have dropped since then.

So we’ve slowed down the dumb money launderers, but others are more circumspect. In fact, their systems for buying real estate are so complex that it takes a suite of diagrams to explain them. “No self-respecting drug trafficker will have anything in his name,” says Inspector Brad Desmarais, head of the Vancouver police gang-crime unit, as he pulls up a PowerPoint on his office computer to illustrate the flow of drug money. Amid family pictures and books on intelligence-led policing, Desmarais, an imposing guy with thick silver hair and a trace of Metis heritage, goes through examples of the way drug money—those bags of cash that have to find a home somehow—moves through the laundry.

First, a dealer will move cash to an offshore entity. Then he goes to buy a house in Vancouver. He makes a small down payment with cleaned-up money and appears to get a mortgage. That mortgage is from the offshore entity, though, and the interest charged is far above the norm. That allows him to make what appear to be legitimate mortgage payments while actually funnelling money back to himself. Since they’re under $10,000 each time, these payments avoid triggering bank attention. There are other ways, too. You could, say, do $800,000 worth of renos and pay partly in cash, under the table. Even if you never recouped it all when you sold, you’d still get some—and that’s what money laundering is all about.

People living off drug-related profits are just another pool of buyers. They may be using elaborate strategies, but they’re not throwing money around on the purchase price, driving up the market. By and large, they do what other rich people do: they pay what the market dictates; and they haggle (Betty Yan managed to knock $2,000 off the price just before she bought). When the rest of us do renovations, of course, we’ll want to make sure we make the money back on resale. Yan’s house, which stayed on the market for a year after her death, sold for only $500,000 more than she paid, in spite of the extensive renovations.

There’s a simpler explanation of what drives Vancouver housing prices up. Drug profits allow some buyers—just as it allows wealthy forest executives and Chinese immigrants—to participate in the collective activity of driving prices up. Housing prices in all cities go up when they experience demand shock. A big new business opens; local sales increase; wages follow. Developers gradually respond to that demand shock by building more housing. But it doesn’t work the same way in every city. Places that have market elasticity—where it’s easy for developers to build—gradually see prices return to a level in line with local incomes. As local incomes rise and fall, housing prices follow the same path.

But in cities that are less elastic—where there’s little developable land, or the regulatory process is onerous—housing prices rise long past the original demand shock. Speculators enter the game. Some are investors, betting the market will keep overheating. Many are simply people who buy beyond their income level, believing the housing market is worth betting on. Prices keep going up because they’ve all become part of a Ponzi scheme, betting that the next set of buyers will make the same calculation they did in deciding to get into the game. It doesn’t take drug money to drive up housing prices. It just takes buyers who act like they’ve been smoking too many funny little cigarettes.

HOW TO BUY A GROW OP

Grow ops—Vancouver’s unique live-work experiment—work their own kind of magic on the real-estate market. If they get confiscated (since 2006, the Attorney General’s Ministry has confiscated 50 properties in B.C., collecting $15 million by selling them), they can end up as bargain-basement sales, bought for $25,000 or $50,000 less than they might otherwise command. (See map left for the 20 seized in Metro Vancouver.)

There’s a science to buying a grow op, says realtor Justin Leigh, who’s worked with buyers in a half-dozen such cases. Ideally, find a house with stigma but no damage. “I did a deal where a neighbour saw new guys moving into a house, bringing in lighting equipment and large bags of soil in the night. The city shut it down,” Leigh says. “It was blacklisted as a grow op even though it was never really operating. That’s a pretty deal.”

A seller is required to disclose whether a house has been a grow op, but owners may claim they had no idea about their tenants’ activities, then sell privately. It can be difficult to check problems with the municipality. “We’ve been spending a number of years trying to get standardization of reporting for properties that were used for drugs,” says Deanna Horn, past president of the Fraser Valley Real Estate Board. Surrey provides realtors with information about a specific address, but not a general list. Other municipalities won’t even do that, citing privacy concerns.

A smart inspector will look for clues like mould and electrical problems. Leigh recently learned a new one: pinholes around the windows where tinfoil was tacked up to keep the house dark. Remember that you can’t always outrun your property’s past. Criminals don’t always follow the real-estate listings. “You can have unsavoury characters coming around and kicking the door down,” warns Leigh. “I know about that stuff firsthand.”—Frances Bula

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