Canadian real estate buyers aren’t so sure about sending prices higher near term. The US Federal Reserve Bank of Dallas (Dallas Fed) released quarterly exuberance indicator for Q4 2018. The indicators, a measure of emotional premiums paid, plummeted over the past year. The drop brought the indicator to the lowest levels in four years. Now to see whether emotional premiums paid over the past 15 quarters can stick.
Exuberance Indicators
The Dallas Fed’s exuberance indicator helps to monitor global real estate bubbles. The indicator measures how much of an emotional premium a buyer is paying. It doesn’t tell you when a correction will occur, just when one is likely to occur. Entering the “critical” range doesn’t necessarily mean a correction is required. Just like falling out the range doesn’t mean a correction has occurred. Instead, it indicates abnormal price movements, far in excess of fundamentals. We’ve explained it multiple times before, so we won’t bore you with an in depth look.
Reading it is simple, considering Fed researchers did all of the hard work. There’s two sets of values – an exuberance index and critical threshold. A price correction is likely to occur when the index is above the critical threshold for 5 quarters. The critical threshold changes over time, so historic peaks aren’t comparable. Even still, you can see abrupt spikes around historic bubbles.
Canadian Real Estate Buyer Exuberance Falls Below Critical
Canadian real estate buyers dropped their lust for buying in the last quarter of 2018. The exuberance index fell to 1.323 in Q4 2018, just below the critical value of 1.325. That’s an 11.86% decline from the previous quarter, and 23.4% lower than last year. Any way that stat is cut, it’s a huge decline from where it was recently. The desire to push prices higher is falling very fast.
Canadian Real Estate Buyer Exuberance
An index of exuberance Canadian real estate buyers are demonstrating, in relation to pricing fundamentals.
Source: Federal Reserve Bank of Dallas, Better Dwelling.
Unfortunately, that doesn’t mean things are back to normal – not yet at least. Only 5 quarters above critical mean a price correction is likely. Canada has printed a whopping 15, and is only 0.002 points below the threshold now. This quarter is only the first quarter to fall below the threshold as well. There’s no guarantee behavior won’t deteriorate further. Additionally, remember how the critical values change every quarter? The gap between the index and critical values is so small, a routine revision could place it above.
Enthusiasm is lower, but optimism is still very high for the marketplace. According to the low volume of buyers in the market, at least. One issue to note is this indicator may be more like the SNLR or SALR indicators. With those, the direction and speed of the movement is more important than the reading itself. People don’t want to know where a market is, so much as they want to know where it’s heading. Right now this is a falling knife, waiting to see if people can stop it from hitting the floor.
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Couldn’t find this in the article – how is “critical value” defined?
It’s the high end of appreciation that fundamentals appreciate at. For example, if fundamentals appreciated at 2-3%, the critical value would be at 3%. If prices rise 5%, it’s above fundamentals, with at least 2% unexplained.
The CMHC used a similar model, when they determined 50% of Toronto price increases from 2010 to 2016 had no fundamental explanation (a.k.a. people paid because other people did). Doesn’t necessarily mean prices will lose 50% of the gains, but it means this is just an agreement between buyers and sellers that it’s worth that much. In the market were to crash, it goes below fundamentals. Food for thought!
They explained both in previous articles IIR. The CMHC data point I didn’t read anywhere else.
Thank you for the explanation Ethan Wu.
Had to happen some time. Now let’s see what 5 quarters of Canadians realizing that housing has a short (5 year) window where you can reap most of the profits. Outside of that, you’re just riding the cycle.
Interesting, thank you
Too bad sellers don’t know this…their exuberance is getting quite annoying. List prices are trending back to silly/stupid in my detached home hood. All the while DOM is becoming a thing to watch. I showed a star-y-eyed neighbour recent comps, and he said, “those are the old comps” the new ones in the weeks to come will be better. Sigh, you can lead someone to water, but you can’t make them drink.
Sumskills, as I was reading your post, I was thinking that it’s not worth explaining a thing to the buyers at the moment. They bought and paid, which to me is quite clear, a premium. I believe they think they got in at the right time with houses only increasing in price. Maybe some can get in and sell and make a profit. While for others looking to live in their house long term, they’ll end up fine.
But most don’t want to hear. They’ve been told by the majority of the media and real estate agents that you need to buy now. Anything “negative” will only upset them.
Like you said, you can lead someone to water, but you can’t make them drink. The well will likely be empty by the time they decide to take a sip.
Joe,
On top of that, when the inevitable happens those same people will say “Nobody could have seen it coming”.
Canada has very diverse real estate markets – so which markets do these stats refer to? The hotbed of Toronto? The cold market of Calgary? Without such details this report is useless. This morning a report came out that the office rental market in Toronto is red hot – companies trying to move into the downtown and elsewhere. That means more employees moving in, more demand for housing. The mortgage stress tests have reduced demand, according to the CIBC, but again there will be regional differences.
It’s a weighted index. Cold markets like Calgary are inflated as well. They’ve gone sideways, when they should have gone down due to credit expansion.
The Bank of Canada disputed the stress test claim from banks just yesterday. Keep in mind that CIBC’s chief economist made that statement. Due to privacy laws, bank economists only have marginally more information than you and I publicly do. They don’t have access to information that would also be considered material, like their bank’s own stats.
They’re all connected Walter by performance of the economy overall. The banks injected Trillions at the end of the 2008 cycle only to shorten the time before the next cycle end. From 10 to 5 now at 2.5. Eventually the injected liquidity has no effect so another method is required within the next 2 years. If they raise rates your looking at about a year so this method has run it’s course. Back to the Glass-Steagall act repealed in 1999 witch incidentally precipitated a huge jump in prices shortly after as you can observe in the graph. Tell folks the money is cheaper and they will run in hoards. If that liquidity had been used in more productive areas like infrastructure, education and innovation we wouldn’t be having this conversation. Let’s all thank Greenspan and his buddies for the concept of forward guidance.
this is a very broad based, generalized study that provides no valuable correlation into if house prices will drop or continue to rise based on buyers exuberence.
it is speculation at best because ‘experts’ have tried every other theory in explaining why real estate assets appreciated significantly higher than their predicted benchmarks year of year….