Canada found a solution to its real estate bubble — a massive revision to historic home prices. The US Federal Reserve Bank of Dallas (the Fed) updated its Exuberance Index for Q1 2022. The index now indicates Canada has just hit a bubble. Odd, since the previous update showed it was in a bubble for more than six years.
It turns out Canada made the largest revision to home prices of any advanced economy… in history. Historical home prices are now much higher than they were, reducing growth drastically. Now the previous bubble has been wiped out, since prices were “always” high — it’s just not what people paid. We know, what is Canada if not a real estate bubble? Don’t worry, it took dedication and hard work, but Canada hit another real estate bubble, even after the data was skewed.
The Exuberance Index
The Fed’s Exuberance Index is one of the most comprehensive bubble indicators in the world. They call it their “smoking gun” for identifying real estate bubbles. It works by looking for sudden acceleration in home prices beyond fundamentals. Fundamentals are things like disposable income and mortgage rates. To do this they standardize the data against a critical value threshold.
The researchers working with the central bank did all of the heavy lifting for us. A quarter of activity above 95% of the critical value threshold marks exuberance. This means buyers are acting on emotion, not any sort of logic. You’ll usually hear people say things like, “I’ll be locked out of the market if I don’t buy now.” Or “we’re running out of land.” It happens every real estate bubble.
One quarter isn’t much of an issue but persistent exuberance can be. If a market shows five consecutive quarters of exuberance, the market is said to be exuberant. That’s code for a real estate bubble, and means it’s time for the central bank to intervene. By addressing a bubble early, they can minimize the economic fallout. No more 2008-style events that can take out the whole global economy.
The researchers say exuberant markets will correct, but it’s difficult to identify when. Emotional buyers require a change in emotion to change the direction of prices. If there’s too much moral hazard built up, even a small correction might not deter exuberance. The longer it persists, the bigger and more dangerous the correction needed.
Canada’s Real Estate Bubble Was One of The Longest Running of Any Advanced Economy
The winter update to the exuberance index showed what you would expect — Canada was a bubble. In fact, it was a bubble for quite some time, right around when it became a pressing issue in the news. Here’s the previous update to Canada’s exuberance index.
Canadian Exuberance Index In Q4 2021
The US Federal Reserve Exuberance Index for Canadian home prices using Canada’s pre-April 2022 methodology for the CREA HPI. Five quarters above the 95% Critical Value threshold marks a bubble.
Source: US Federal Reserve Bank of Dallas; Better Dwelling.
This chart shows Canada was a real estate bubble for 6.5 years as of Q4 2021. Most Canadians would say this is when the froth started in Toronto and Vancouver. Some even argue the real estate bubble goes back to 2013, when Tiff Macklem was warning about it. Yeah, that Tiff Macklem.
You can imagine my surprise when I opened up the latest dataset from the Fed to check on it and… drumroll.
Canadian Exuberance Index Q1 2022
The US Federal Reserve Exuberance Index for Canadian home prices using Canada’s post-May 2022 methodology for the CREA HPI. Five quarters above the 95% Critical Value threshold marks a bubble.
Source: US Federal Reserve Bank of Dallas; Better Dwelling.
… according to the new data, Canada only just entered a real estate bubble. The first case of exuberance occurs in Q1 2021 only just hitting a bubble in the most recent quarter. It struck me almost immediately — Canada revised its price data methodology.
Canada’s Big Change When Measuring Real Estate Prices Boosted Prior Years
The CREA House Price Index (HPI) is routinely revised, with a minor adjustment every year. This year was different, rolling out a major change to how they measure data. As we pointed out earlier this year, there was a technical revision significantly impacting the past 5 years of data.
“Under the new methodology, benchmark attribute data is derived from data collected from the previous five-year rolling period. Benchmark prices are also now based on current benchmark attributes instead of linking benchmark prices to historical benchmark attributes.”
— Real Estate Board of Greater Vancouver (REBGV)
In plain English, it was re-weighted to place emphasis on a rolling average of data from 2017. That’s around the period where Toronto and Vancouver began to correct. Naturally, I reached out to a contact at the Fed to ask if this was the case, and they confirmed the change. A few hours later, in what seemed like a what-the-heck moment, they emailed the differences in the data.
Canadian Real Estate Prices
The benchmark price of a composite and single-family detached home indexed using both the old methodology and the new methodology.
Source: US Federal Reserve Bank of Dallas; CREA.
As stated above, methodology changes are routine. However, they usually are just a few thousand dollars in either direction. However, this is a significant change in how they measure home prices.
The old methodology shows a 64.3% increase for composite home prices from the May 2017 to March 2022 peaks. The revised methodology shifts the peaks, and reduces that growth to just 49.2% — about 15 points lower. The new 2017 peak is also 19.5% higher than the previous one.
Imagine how data is influenced when you say in 2017 homeowners paid 20% more due to a methodology change? Or shave 15 points off a bubble’s growth? Is it still a bubble? It turns out it isn’t, as reflected in changes in the Exuberance Index.
Coincidentally, prices will reach the 2017 peak value much faster using this method. If it were a stock, technical traders would consider the 2017 peak to be the support level. Having it much higher is a huge advantage from a psychological standpoint.
Composite baskets change frequently, but the single-family prices are even worse. Those are a relatively stable composition, and it shows 65.8% peak-to-peak growth. The new methodology shaves over 17 points of growth off that level. You might have used the old methodology to buy at the peak, but you’re using the new methodology to sell on the way down. You’ll hit 2017 levels a whole 16 points faster now. Good for you.
The Fed researcher said it was “surprising,” since it completely changes historical interpretation. In fact, they track home prices in every advanced economy and haven’t seen a revision like this before. Much of Canada’s frothy growth was just minimized with the stroke of a button. Housing is considered the primary investment for most households in Canada. Would you just historically revise the price of stock performance? Probably not, but in real estate no one even batted a lash.
Don’t get this wrong. No one’s implying this is an intentional market distortion (nor am I dismissing it). It’s the same criticism I expressed when I was invited to talk to Stat Can’s management about CPI. They made a major revision to how inflation is measured in the middle of a crisis. As National Bank warned, it will chronically underreport inflation. This is a major reason why Canada’s inflation is lower than the US, despite a weaker loonie and commodities being priced in US dollars.
Analysts are often just excited to use a new measurement. They may not have been thinking, “how does this impact resolving the current issue presented by the data?” In fact, they don’t consider it their problem to solve — they just deal with data. If you don’t want targets to move, make your own. This is one of the issues with considering home sale prices private information, unlike other advanced economies that feel it’s essential for the public to have free access to public sold data. Imagine not knowing what a stock price used to be unless you contacted a broker?
That’s essentially the issue we’re seeing with Canada’s real estate prices now. A new methodology change analysts are excited to use, just happens to wipe out the issue being tracked.
Why would Canada need to correct a real estate bubble? It never had one. On the upside, it’s pretty funny that the bubble was wiped out through data changes and Canada hit a bubble again. Can’t keep a good bubble deflated. Sempre altior.