Canadian real estate is still in bubble territory but excitement is fading fast. The US Federal Reserve (US Fed) Exuberance Index for Q3 2021 shows Canada is still in bubble territory. At this point, the gap between fundamentals and price have expanded for over a half decade. As higher rates approach, the index is showing a rapid collapse of sentiment, though. Central bank researchers generally believe markets that show persistent exuberance will correct. When is more of a mystery.
The US Fed Exuberance Index measures “explosive dynamics” in housing markets. Explosive dynamics is how economists say price growth greater than fundamentals support. It’s a little more discreet so the average person doesn’t get upset. If a buyer isn’t buying on fundamentals, they’re buying based on emotion. The problem with buying on emotions is they can change as fast as the weather. If that happens, there’s not a lot between the fundamental value and the current market price.
The central bank’s research looks for persistent exuberance to identify whether it’s problematic. One or two quarters of growth in excess of fundamentals happens, and isn’t enough to write home about. When it occurs for five or more quarters, the researchers believe the market is now exuberant. An exuberant market is also known as a bubble, and they believe it will result in a correction.
Canada’s Real Estate Bubble Is 26 Quarters Old
Happy quarter birthday! Canadian real estate has been a bubble for over half a decade now. The model shows Q3 2021 is the 26th quarter the market has shown exuberance, working out to 6.5 years. The first sign of exuberance occurs in Q2 2015, and it logged the fifth quarter making it a bubble in mid-2016. This is a very long time for the gap between fundamentals and prices to expand, and it’s still widening.
Canadian Real Estate Exuberance Index
The US Federal Reserve Exuberance Index for Canada, and critical value threshold. A market that is above the threshold for 5 consecutive quarters is considered to be exuberant.
Source: US Federal Reserve, Better Dwelling.
Exuberance For Canadian Real Estate Is Falling Fast
The exuberance index is making an abrupt break lower, showing slowing sentiment. Canada might have logged 6.5 years in a bubble, but buyers aren’t as enthusiastic as they once were. The last time the index fell this fast preceded a price correction in Toronto and Vancouver. A flood of cheap mortgages, disposable income, and the promise of massive profits reversed that in 2020. The last time the US saw such a rapid collapse of the index was around 2006. Take what you will from that.
Canadian real estate buyers are still showing significant exuberance, but it’s losing a little steam. This isn’t unexpected to see enthusiasm slow as annual price growth hits a new record high and interest rates climb. Even falling sentiment at these levels can still have enough momentum to drive price growth in the short-term.
More indicators are beginning to reflect a cooling of sentiment, though. Falling new housing starts and slowing new mortgages are more recent data points that might agree buyers are past their peak. It’s hard to see that while they’re still paying tens of thousands more per month. The depth of that market is still unknown, and won’t be apparent until the Spring.