Wednesday, June 13, 2012

G&M Debate on the Existence of a Canadian Bubble

Part 3 of a multipart debate in the Globe and Mail. Mandani knows his stuff. Where are Canadian real estate prices heading?
Many housing experts thought that U.S. house prices at the peak would keep rising because of strong demand and housing shortages. Many experts also dismissed what traditional price-to-income and price-to-rent ratios were warning them.

One important lesson from the U.S. experience was that the strong demand caused by changes in household formation created "perceived" housing shortages. These perceived shortages (or pent up demand) eventually led to excessive new home building and speculation in existing housing markets, pushing house prices too high. But now that the bubble has burst, the housing shortage problem has vanished.
The above should be printed in giant flashing letters. The speculative bubble creates the very conditions that make the speculative bubble seem rational. But those conditions are just as ephemeral as the equity they are artificially boosting.
CMHC has artificially boosted household formation rates, reflected by the decade-long upswing in Canada's home ownership rate, to almost 70 per cent from roughly 63 per cent over 10 years ago. This is a big change over such a short period of time.
And it can revert even faster.
It will end whenever buyers perceive that prices are no longer going up. Hence bubbles carry the seeds of their own destruction.
This. TD's prediction of a 15% fall ("at least 15%") seems wildly optimistic. Once the "get in now or be priced out forever" is shown to be the lie that it is, why would anyone overextend rather than wait?

Then Helmut follows up with one of the classic: We're running out of land!
Research shows that markets with a restricted land supply experience larger swings in prices when demand changes, since the supply curve is relatively inelastic. The boom/bust cycle in markets associated with more land restrictions is largely due to these fundamentals not to speculation.
Helmut, seriously, there has been a shortage of condos in Toronto and Vancouver? No, there have been a lot of underutilized condos stacked like poker chips at the table. Mandani has it right. Look at China. 64 million empty apartments later and the price STILL wouldn't have fallen if the government hadn't put restrictions on purchases. Oversupply does not slow price growth if credit is ballooning. Why does the U.S. have 7-11 million empty houses, post-bubble, if supply was constrained during the bubble? This is such a dead argument, but it always gets hauled out by the pave-the-earth crowd.
High turnover in existing housing markets is not sufficient evidence of speculation, unless turnover is defined as short-term buy and sell transactions, rather than the buy and hold transactions of most home purchasers.
The mantras of "buy now or be priced out forever" "get on the property ladder so you can leverage up" imply buy and hold with a strong speculative component. Do you have *anything* new to say, Helmut? This is the same beaten-to-death stuff that was just disproven in the U.S.
Prices can be high because of economic and market fundamentals. Market excesses can develop and occur under certain conditions.
Yadda yadda, paradigm shift (yawn). Yes, and when those "certain conditions" end? What then? That *is* the bear argument point, which you avoid taking your logical conclusion out to. "Certain conditions" are temporary. By the way, any specifics that actually apply or just macro-speak? [glancing down] Nope.
Conservative practices by mortgage lenders, tighter mortgage insurance conditions, and more regulatory oversight since the last recession mean tighter, not easier credit.
Ah, this is different, at least. We have a lot of anecdotal evidence otherwise, but nothing more. Because CMHCs books are not open. Open CMHCs books (hey, the public owns them, right?) then you can toss out assertions like this in the face of 70% ownership rates in Vancouver living cheek to jowl with prices that require the average household to spend 90% of their pre-tax money on a mortgage.
Toronto’s apartment condominium market is undergoing high levels of new investment and overbuilding could occur. If so, it is likely to be limited to that sector and have little or no effect on other markets.
"It's contained." You hauled that one out? Oh, dude, so noted.
The next housing recession will occur with the next economic recession and not because the price-income ratio is high. The trigger for every post-war housing recession in Canada has been external to housing and the next time will be no different.
This would explain why the bull analysts in Canada already blaming Europe for the downturn. Okay, let's step through this: If prices are in line with fundamentals, why are they so fragile? In a downturn, there is a flight to safety. If houses are so overwhelmingly safe, and prices are not in excess of fundamentals (based on some new paradigm) why would they fall at all in the face of a recession? You can't have it both ways.

Truth is, houses do have a real value, it's based on rents. In the U.S. we've watched house prices grind downward to the point at which a landlord will scoop them up for a 5-6% cap rate. Those buyers materialize no matter the environment (even with bank lending frozen). In a downturn where a bank account pays 0.1% interest, rentals make great investments. Trouble is, you are trying to claim that there is a new "fundamental" that is not based on economic return but on leverage of a misinformed, emotionally manipulated consumer. That's why the price is fragile. That's why its in a bubble. That's why a recession will change the price. If a recession is capable of changing the price (as you yourself stated) then you are acknowledging the existence of a cycle and acknowledging that prices are above true economic fundamentals. You just can't bear the word "bubble," but you just admitted it existed. Why you bothered, I don't know. All of that macro hot air, and your conclusion is: "well, sure, prices will fall, when there is an external shock to the system that forces prices back to true fundamentals." Right. Can't disagree with that.

Btw, that's not the only way it can happen, you can also tighten lending, cutting off the market's access to untapped greater fools. But keep blaming Europe if it makes you feel better.

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