Montreal is the next Manhattan. Or maybe Winnipeg. Sorry, it’s definitely St. Johns. Wait… what’s happening? Real estate prices are rising pretty much across the country. Canadian real estate prices are showing the highest level of price synchronization in years. This is when markets, regardless of location, begin to show similar levels of price growth.
Asset price synchronization typically indicates market participants have become irrational. That’s not just a problem because high prices impact affordability. It means all markets are more likely to be vulnerable to a single shock factor. It’s like putting all of your mortgages in one basket.
Efficient Markets and Synchronization Risk
We need to get nerdy for a second, so bare with us. The efficient market hypothesis is the belief asset prices reflect all available material. If someone mis-prices an asset (sells too low or too high), it’s just an outlier the rest of the market will fix. Therefore, the price is always correct. It’s never wrong, because there’s not enough irrational players to skew the market. As ridiculous as it sounds, it’s the most common belief. Despite foundational economists like Adam Smith and John Maynard Keynes saying irrational behavior has a significant impact on markets, and that’s why bubbles exist.
In behavioral finance, they believe we’re just chimps in pants. We’re prone to making mistakes, and people will mimic each other’s behavior. One of those mistakes is knowing something doesn’t make sense, but pursuing it anyway. In this case, people chase the same opportunities as their friends, without rationale… like buying a Nickelback album. This is called synchronization, and it results in the mis-pricing of assets.
The more synchronized markets are, the more likely people are disregarding rational behavior. Markets may have common factors, but they’re all unique. For example, a high demand housing market shouldn’t rise with a market that’s losing people. Synchronized behavior doesn’t consider those factors. Usually every market will have a similar reason for why prices are rising or falling together. You think home prices should rise in an area with a declining population, because debt is cheap? Cute.
How Do We Identify Synchronization?
Okay, so how do we identify these risks? A lot of ways, but today we’re going to look at price growth synchronization. We’re going to look at the relationship between national, city, and rural. There’s 46 markets used in today’s analysis, grouped by economic region. For institutional subscribers, individual cities are already on the portal. We’ll also share a further breakdown on Twitter next week, for our Twitter fam.
Note the index is experimental right now, but we’ll be fine tuning it for more regular updates.
How do you read the data? We used a standard scale that starts at -1 and goes up to +1. If the correlation coefficient is -1, it means there’s a perfect negative correlation. In this case, that would mean a regional market showed price growth that was perfectly inverse to the national growth trend. That is, if national home prices increased, the market dropped perfectly in sync, and vice versa.
If the correlation coefficient is 1, it means the market is highly synchronized with the national price movement. If national prices rise, so does the regional market. If national prices fall, so does the regional market. This would mean the market is likely to be emotionally driven.
There’s also degrees of correlation, depending on where the correlation coefficient is.
- Very Highly: 0.9 to 1.0
- Highly 0.7 to 0.9
- Moderate: 0.5 to 0.7
- Low: 0.3 o 0.5
- None found: 0.0 to 0.3
- None found 0.0 to -0.3
- Low -0.3 to 0.5
- Moderate -0.5 to 0.7
- Highly -0.7 to 0.9
- Very Highly -0.9 to 1.0
Canadian Real Estate Prices Show High Synchronization Risk
Canadian real estate markets were the most synchronized since the Great Recession. Price growth of markets printed a correlation coefficient of 0.97 in January. This is the most highly synchronized the markets have been since June 2010. The index only became highly synchronized in September 2020, and very highly in November 2020. If you’ve spoken to a Canadian, you’ve probably realized they all think they live in the next hot market. Even the markets with negative population growth, and fleeing young people.
Canadian Real Estate Synchronization Risk
The degree of synchronization between National price growth, and regional growth. Higher index scores mean more synchronization, and lower means less.Source: Better Dwelling.
Ontario’s Suburbs Show High Synchronization Risk
Ontario’s real estate markets have seen this level of synchronization recently. It’s a little different this time though. The market’s print was 0.95 for January, indicating it was very highly synchronized to the national trend. The market became highly synchronized in Aug 2020, and very highly by November. This isn’t as distant of a phenomenon for Ontario, with these levels last seen in 2018.
Ontario Real Estate Synchronization Risk
The degree of synchronization between National price growth, and Ontario real estate price growth. Higher index scores mean more synchronization, and lower means less.Source: Better Dwelling.
One big difference is Toronto is largely left out of this trend this time. The city only printed a 0.78 score for January, the lowest level since November 2019. As recently as May 2020, it showed a 0.99 score. Removing Toronto from the index highlights how much of an outlier the region is.
The spread between Ontario’s least and most correlated market is 119%. This means the market most synchronized to the national trend is more than double the least synchronized. If Greater Toronto and Oakville are removed, the spread drops to just 17%. Both regions had very large surges in price growth in 2017. However, currently condo apartments are lagging in growth. Toronto’s condos printed the first negative price growth in years recently.
BC Real Estate Is Frequently Synchronized To The National Trend
BC real estate is frequently correlated with national price trends, unlike most regions. The market printed 0.93 in January, showing it was very highly synchronized. When Lower Mainland is excluded, that number bumps higher to 0.95. Once again, this is likely to do with slower city sales, especially in the condo apartment segment.
BC Real Estate Synchronization Risk
The degree of synchronization between National price growth, and BC real estate price growth. Higher index scores mean more synchronization, and lower means less.Source: Better Dwelling.
Greater Vancouver is a huge drag on the numbers, actually diverging from the trend. The region’s correlation coefficient was 0.82 in January, which is highly synchronized. It’s just not at the same level as the rest of the province. As recently as October 2020 it was 0.91, and was 0.99 in March 2020. Before the pandemic, it was basically driving the trend. The drop most likely has to do with slower condo apartment demand.
Quebec Real Estate Has The Highest Synchronization Risk Since The Great Recession
Quebec real estate is highly synchronized to the national price growth trend. The province’s score was 0.94 in January, indicating a very high level of synchronization. The level was last this high in June 2010. Prior to 2019, that was peak price growth for the region.
Quebec Real Estate Synchronization Risk
The degree of synchronization between National price growth, and Quebec real estate price growth. Higher index scores mean more synchronization, and lower means less.Source: Better Dwelling.
Prairie Real Estate Shows Highest Synchronization Since Peak Oil
The Prairies showed the highest synchronization with national prices in almost a decade. The index printed 0.93 for January, a level not seen since December 2011. That would have been right around peak oil prices.
Prairie Real Estate Synchronization Risk
The degree of synchronization between National price growth, and Prairie real estate price growth. Higher index scores mean more synchronization, and lower means less.Source: Better Dwelling.
Atlantic Canada Shows Highest Synchronization In At Least 16 Years
Even Atlantic Canada is showing synchronized price growth, which is rare. The region came in at 0.96 for January, indicating it was very highly synchronized. This is new territory, with no prior connection to national price growth since at least 2005.
Atlantic Canadian Real Estate Synchronization Risk
The degree of synchronization between National price growth, and Atlantic Canadian real estate price growth. Higher index scores mean more synchronization, and lower means less.Source: Better Dwelling.
Synchronization of asset price growth across markets is never a good thing, and there’s a reason it’s a whole branch of risk. It’s typically indicative of overly loose policy, excessive leverage, and irrational behavior. More important, it means people are piling into a similar type of risk. This means the odds of a single vulnerability impacting all markets increases.
While that sounds all theoretical, it gets less so when you realize even banks have begun to warn. BMO recently said if mortgage rates stay the same and prices continue, affordability reaches classic bubble territory next year. If mortgage rates increase to pre-pandemic levels, it also becomes a classic bubble. At least you’re all in this together.
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