Prices just outside of frothy Canadian real estate markets are growing much faster than in the city. That’s typical of a bubble, and it’s called “housing bubble contagion.” In a paper titled Housing Bubble Contagion From City Centre To Suburbs, three Taiwan-based researchers argue bubbles spread outwards. Bubbles force investors and developers to look for “deals” outside of the city, sending prices soaring. The result is a larger bubble, with suburban prices being much more frothy. Looking at Canadian real estate data, that’s exactly what’s happening in Canada.
Housing Bubble Contagion
Home prices diffuse from a central hub or major city, to the surrounding areas. That’s well established. It wasn’t until 2017 that these researchers discovered bubbles follow the same path. It’s often mistaken as a spread of fundamentals.
When this happens, it’s called a “bubble contagion.” Not unlike a virus, the host is infecting those with close contact. The issue is passed from person to person, but instead of getting sick, they think a teardown bungalow is worth two million.
It actually makes a lot of sense, considering the psychology of a bubble. Prof Jean-Paul Rodrigue infamously broke down the bubble mindset into four phases:
- stealth, when smart money begins to accumulate a position, and place big bets;
- awareness, where institutional investors start to see opportunity;
- the mania, when prices start to really take off after the public jumps in, and smart money begins to rotate out; and
- the blow off, where people are terrified to touch the asset, after watching everyone lose a whack of money in the decision.
The bubble contagion theory puts a unique spin on real estate bubbles. Unlike a stock, the public can’t just buy a few shares for further exposure to the market. Instead, they usually need to buy a whole home, or pool with other investors. When prices rise to, oh, I don’t know, the point where only 5% of the population can buy, those that want to speculate, can’t.
Main Stages of An Asset Bubble
The result is aspiring investors, and the real estate developers who love them, look to the burbs. The researchers observed bubble behavior moving from the City Centre of New Taipei to the suburbs. An influx of money tends to produce an even bigger bubble than had been contained to just the city. The suburban bubble often sees a bigger gap between the price and funamdentals.
Canadian Real Estate Prices Are In A Bubble
Canadian real estate is in a bubble, and that’s not just my opinion — it’s the opinion of finance authorities. Not professionals, authorities. The US Federal Reserve has Canadian real estate in its 19th consecutive bubble quarter. Bank of Canada (BoC) also created a similar model, but said bubbles were limited to Toronto, Hamilton, and Montreal.
The IMF also estimates some cities need big drops to reach fundamentals: Toronto (28%), Vancouver (15%), and Hamilton (29.6%). So let’s skip the debate, and accept that the bubble is as real as government incompetence..
Housing Bubble Contagion Is Spreading Across Canada
BoC research also shows the housing bubble contagion is already spreading. They just won’t acknowledge it. They found Toronto homes located within one kilometer of the city center saw annual price growth fall 1.9% in the fourth quarter of 2020. Once you get 30km out, double-digit annual price growth becomes normal. When you hit 64 km, prices were making 19% annual growth. Toronto now has banks warning, make sure you really want that surban property, because you may be stuck with it.
Toronto Real Estate Prices From City CenterThe annual percent change in Toronto home prices, by the distance from the city center. Source: BoC; Teranet; Better Dwelling.
Similarly in Vancouver, home prices are rising much faster outside of the city as well. Within one kilometer of the city center, annual home price growth fell 1.3 percent in the fourth quarter of 2020. Between 40 and 60 kilometers from the city center, growth is consistently above the baseline trend.
Vancouver Real Estate Prices From City CenterThe annual percent change in Vancouver home prices, by the distance from the city center. Source: BoC; Teranet; Better Dwelling.
Home Buyers Flee To The Suburbs For “More Space” In Every Bubble
The pandemic changed buying habits though, so this time it’s different — right? Maybe, but maybe not. The researchers said, “… abnormal demand shock qualifies as a bubble.” In other words, it doesn’t matter if people all of a sudden really, really want to buy a home because of low rates. An increase in price that’s abrupt and not ground in a change in local market fundamentals isn’t a rational price movement. Ditto with, “I had to pay 20% over ask because 72 people also bid.” It’s not a bubble if one person does it. It’s a bubble if everyone thinks what that person did was normal.
Besides, the suburban “this time’s different” narrative has popped up many times before. In Toronto’s late 80s/early 90s bubble, a Globe and Mail article titled Toronto’s Growth Moves Away From The Core (15 May 1989) was published. The journalist mentioned people were fleeing the city, due to the “high rents, traffic congestion, and restricted development of downtown Toronto.” Then prices went up forever, and people stopped moving to Toronto because it just kept getting less affordable. Kidding. Prices cratered and values didn’t recover until the 2010s in real terms.
In the early 1980s bubble, a piece titled Bigger, Better Home Seen As Family Refuge During Tough Times appeared in the Toronto Star. In it the author said global catastrophes have people seeking out larger homes in the suburbs. More family time and outdoor space were of sudden interest.
These aren’t new issues. It’s the same justification surrounding the same frothy behavior people demonstrate. People aren’t robots, they’re irrational. They do irrational things. They are hardwired to justify those things though.
Canada Is Doing Literally The Opposite Of What They Should Do To Stop Bubble Contagion
Not unlike any other contagion, nipping a bubble in the bud, as quickly as possible is the best solution. The researchers found if a city becomes exuberant, suppressing market activity limits the damage. In the event it spreads to the suburbs, it becomes more problematic. It increases the chance shock will be felt.
“To prevent the financial crisis because of the housing bubble from bursting, the central bank should implement measures that are more stringent in suburbs such as raising the mortgage rate, implementing loan controls to reduce the money supply, and limiting the amount for construction loans,” say the researchers.
Canada recently loosened measures, lowered mortgage rates beyond market rates using QE, expanded the money supply rapidly, and is providing construction loans. If Canada has any real estate bubbles, it’s literally doing the exact opposite of what it should be doing to prevent a financial crisis.
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