The US Federal Reserve Has Canadian Real Estate Back In Bubble Territory

Canadian real estate buyers are still feeling exuberant about the market. The US Federal Reserve Bank of Dallas‘ (Dallas Fed) exuberance indicator shows expectations are still high in Q3 2019. The index measures explosive price growth, that’s detached from fundamentals. Expectations are much lower than they were in 2017, but are still above critical levels.

Exuberance Index

The exuberance index is the tool the US Federal Reserve developed to track housing bubbles. The indicator measures buying behavior in contrast to income developments, and looks for explosive dynamics. That’s what econo-nerds call unusually fast rising prices. A rapid increase in price is usually due to emotion, which is a detachment from fundamentals.

Emotional premiums tend to not stick around very long, since they’re volatile. Events such as policy, recession, or employment can quickly deflate expectations. As a result, when buyers are grounded in reality by one of these events, the premiums can disappear. This is more commonly referred to as a correction or crash, depending on how fast it happens.

Efthymios Pavlidis and the Dallas Fed developed an index to track exuberance. They publish two sets of numbers – an exuberance indicator, and a threshold value. If the indicator rises above the 95% critical threshold value, buyers are acting exuberant. If the indicator stays above the threshold for more than 5 quarters, the market is said to be exuberant. It’s complicated, but not at the same time.

Canadian Real Estate Buyer Exuberance Is Back

Canadian real estate buyer expectations have cooled down, but they’re still elevated. The Dallas Fed has buyers in Q3 2019 at a level 3.1% lower than the previous quarter. The most recent quarter is also reading 12.6% lower than the same quarter last year. The only quarter lower in the past few years, was in the beginning of last year – when the market was cooling down. That was very brief.

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.

Exuberance is much lower than it was at the recent peak, but it’s still very high. The indicator has fallen 63.2% from the most recent peak in Q2 2017. If you consider the Q1 2019 drop below the threshold a blip, this is the 19th quarter of exuberance. Remember, the market is declared exuberant after 5 consecutive months above.

Confused? That’s because the Canadian real estate market is very confusing right now. After twelve consecutive months of rapid price acceleration, expectations lowered for a quarter. Literally 4 days after that quarter ended, Canada announced a policy reigniting enthusiasm. The size of the program is small, but the message is big – the government will try to bolster prices. If 12 quarters of exuberance set the prices they’re willing to try and preserve, what’s another few quarters?

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  • Mortgage Guy 2 years ago

    One thing not being measured is pre-sale expectations. Toronto is back to sending developers to China, to see if they’ll fuel another leg.

    • Terry 2 years ago

      Ditto with Vancouver. We’ve entered the pre-sold, before pre-sale launch phase. You can sign-up for a project that isn’t selling, and they won’t announce it until they’re sure the units released can be reasonably sold.

  • Marc 2 years ago

    RBC forecast higher taxes and “demographic time bomb,” but somehow concludes home prices will continue to get more expensive.

    If young people are already making six figures, and they’ll have to pay more than 50% of their income to taxes… why wouldn’t they just move to cities like San Francisco where housing is cheaper?

    • Mortgage Guy 2 years ago

      Nail on the head. Not sure if you’re old enough, but that’s a large part of what brain drain was in the 90s. Canada was fine, because we replaced high income earners with multiple immigrants.

      Of course, that didn’t help home prices, since they needed to adjust to the new immigrant incomes, which often don’t even reach the full Canadian-educated levels. I’m sure that gap will close, but it’s still not a quick fix that will materialize soon.

  • Ethan Wu 2 years ago

    The elephant in the room: if nothing has deflated prices in the past 15 quarters, what will deflate them? Most of today’s buyers have never experienced a correction, so unless they experience one – they won’t have any fear of risk.

    • Leon 2 years ago

      You’re 100 percent correct. If majority of the buyers in the last 15 quarters never experienced any house price correction then all hands on deck. My next door neighbor a new immigrant has their house on the market and I asked why is it me you just moved in 2 years ago. Her response was no it’s not you but it’s time to sell so we can buy 2 more houses. The husband work and she stays home with 2 kids. Just shows you no fear at all.

  • Asterix1 2 years ago

    Single detached prices in GTA have gone nowhere in the past 15 quarters!!

    Average price: 416
    September 2016 = 1,284,000 VS December 2019 = 1,361,000
    *The prices are exactly where they should be once Inflation adjusted.

    Same for 905
    August 2016 = 905,000 VS December 2019= 956,000
    *Exactly where prices should be once inflation is added.

    Add in closing costs, selling costs, mortgage interests, maintenance, insurance etc…

    It’s a loss….

  • Lorence 2 years ago

    Okay, so the the chart shows an exuberance level bounce off a “critical values” line that may be taken as a critical support level, but nothing goes to hell in a straight line and it needs more time to come to any sort of definitive conclusion about a trend. I think it’s still downward but narrative for those that haven’t seen real estate values go under water is that the worst is over and I don’t think this will end well for speculators.

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