Housing Bubbles: True or False? Part 2

مالی و اقتصادی — 03 اکتبر 2012

By Behnam Rad

The housing market is becoming hotter and hotter these days. Up to four weeks ago, you could hardly find any decent homes on the market. The houses which were showing up on the market were either leftovers from November of last year, or were the houses in which no tenants resided and had been recently renovated. Now however, the market is booming! More and more houses are showing up on the market everyday and most of them are sold and gone within a week. It has become normal to have the house listed on Wednesday, have an open house over the weekend, and have the owners accept offers by Monday evening; seriously, it is unbelievable. By the way, if you are planning to renovate your house this summer to either add value to the property or just for the sake of renovating the house, it would be a good idea to attend an open houses in your neighborhood on the weekends between 2-4 PM in order to get an idea of what works and what doesn’t.

Take your camera with you and take pictures, and if by any chance the owners are present, don’t be shy to ask them how they renovated because there are always stories behind each renovation and owners will be happy to share it with you. Try it, it will be fun and you won’t be disappointed. In fact, I would like to hear from you as well so please share it with me by sending me an email!

If the market is booming and most of the houses are sold in less than a week, does that mean that we are safe from housing bubbles? Does this mean that there is nothing to be worried about and that a housing bubble is not going to happen?

In the previous article, I discussed various parameters which can affect the housing market.

GDP (Gross Domestic Product), which is the time and effort you put into making something out of raw material, has direct relation with income. Higher incomes allow for higher buying powers, which create competition in moving to better neighborhood, therefore leading to increases in the prices of properties.

Inflation, the increase of prices in goods and services over a period of time, can present itself as either a Demand-Pull inflation or Cost-Push inflation. In Demand-Pull inflation, prices go up because of an increase in GDP and increases in buying power, while in Cost-Push inflation, prices go up because of decreases in the supply of raw materials which cause businesses to buy raw material with higher prices and charge more for their services thus creating a ripple effect in the economy. The latter one is very destructive.

Immigration, which is equal to demand, is increasing year after year. If supply can’t meet the demand, there will be an increase in the prices for sure.

Low mortgage rates increase the number of borrowers, increase the borrowers’ buying power, and increase their desire for buying bigger houses beyond their affordability power which eventually causes the increase in the prices.

Now that we know what parameters affect housing prices, the question is if there have been any housing bubbles in Canada before. To answer your question, there have been three housing bubbles in Canada before: Vancouver 1981, Toronto 1989, and Vancouver 1994.

The housing bubble in Toronto is the one that had a big effect on the economy, and is thus the one that everybody remembers and talks about. It started in 1985 and reached its peak in 1989 until it finally started fading away in 1994.

The housing prices ramped up in 1985. For two years prior to 1985, the average price of a house in the GTA was $95000. By the end of 1989, this price had become close to $260000; an almost 274% increase in four years while it should have normally been a 20% to 25% increase.

GDP had a significant increase in 1987 and 1988 prior to the crash, but the rate decreased heavily from 1990 to 1992.

The rate of unemployment started decreasing from 1985 and hit its lowest rate in January 1989. It wasn’t until after the bubble that it started going up, till around January 1994.

The rate of immigration in Ontario had greatly increased to 70% from 1985 to 1986, but started to drop down to 9% and 4% in 1990 and 1991.

The mortgage rate experienced a huge increase in four years and reached 12.7% during 1989. One year later, in 1990, it had reached 14%, thus finalizing the crash in the housing market in Toronto.

There is one more indicator that is worth mentioning here and that is the Affordability Indicator.

The Affordability Indicator is the share of average household income which goes towards mortgage principals and interests, property taxes, and utilities for the average priced home.

This indicator started at 35% in 1986 and reached close to 55% by 1989, which has been the highest rate in past two decades.

As you can see, the increase in the rate of immigration to Ontario in 1986 increased the demand for new houses. Housing builders started to build more houses to respond to the demand, but because of the growth in GDP and increase in rate of employment, home buyers started to compete for buying houses in better neighborhood which eventually drove the prices even higher.

In order to dampen the increase in prices, banks increased the mortgage rate aggressively in four years, up to 12%, which lowered the affordability of the home buyers. The home owners couldn’t afford paying the mortgage of their homes, and the immigrants couldn’t afford buying new houses. This led to home builders becoming unable to afford paying their debts to the bank since nobody was buying the newly built houses, and all of these factors together ended up crashing the housing market in 1989 in Toronto.

It took 4 years for the housing market to recover from this crash.

It is interesting to know that by the end of 1993, the housing prices in Toronto dropped by an average of 30% which meant a 100% increase in 9 years, from $95000 in 1985.

It is also interesting to know that condominium prices experienced a significant drop after the crash in 1989 in comparison to single homes because most of the activities and most of the newly built houses were in the condominium market.

The 1994 housing bubble in Vancouver however, was a completely a separate incident from what happened in Toronto as it wasn’t quite a bubble, but more like a correction.

The unemployment rate was fairly stable in Vancouver of 1994 but the increase in rate of immigration from 1994 to 1996 caused an increase in prices. The interest rates however, were also going down after what happened in Toronto in 1989 and the rates were fairly low in 1994 thus leading to the main reason that a crash like the one in Toronto didn’t happen in Vancouver. The housing prices dropped, by 16% on average, in Vancouver.

Now that we know what has previously occurred in the housing markets, we can now look at the current market and see whether the same symptoms and triggers are happening during the current housing market. In our next article, we will focus on the current housing market and discuss what we can do to get through a housing bubble, in the case that another bubble develops in today’s market.

Real Estate Investor

behnam.rad@sigmarealty.ca