No, we won’t call Toronto real estate a bubble today. Usually we shy away from using the B-word entirely. Canadians tend to look at you like you’ve insulted their mother when you say it. Instead we’re going to discuss the phases of a real estate bubble, and let you make a decision for yourself. Understanding where you are in an asset cycle is a key difference between dumb luck, and calculated risk. It’s also what separates the rich from the middle class.
The Stages of An Asset Bubble
Cyclical behavior is usually broken down into 4 main stages, and lucky for us that’s what a prof did with bubbles. Today we’re going to use Dr. Jean-Paul Rodrigue’s infamous chart, which he published in 2008. During the Great Recession, this chart became legendary for capturing behavior, and viewed as a schedule for what’s next. It became popular again last year, as the crypto bubble inflated and popped. The four phases are stealth, awareness, mania, and the blow-off. Let’s touch on what’s typically observed during each period.
The Stealth Phase
The stealth phase is where you see smart money, and sometimes their buying seems a little crazy. This is when the general public couldn’t care less about buying the asset. Usually because it’s during a recession, or in such infancy it attracts no attention. Concord Pacific buying a sixth of downtown Toronto in 1996 is one of the best examples of this in my opinion. People thought they were crazy, because who wants to live in a downtown condo after what happened in 1990?
Prices are mostly flat during this period.
The awareness phase is when institutional money starts entering the market. Prices move a little higher, and the previous bubble’s buyers spring into action to “cut” losses. This is called a “bear trap,” because some bears claim it’s the end of the world and you missed your opportunity. There were a few bear traps in Toronto around the Great Recession, right up to 2015.
Prices move very quickly, but they haven’t started to climb vertically at this point.
Note: Toronto’s bear traps didn’t make sense during this period, especially before 2012. Toronto real estate prices didn’t hit the 1990 high until 2012, in real terms. Real terms is just fancy-talk for inflation adjusted.
The mania phase is when the public becomes very aware, and it’s all you’ll hear about from the media. Everyone that made a few bucks, tells their friends, and FOMO sends prices higher. Pro-tip, watch if the people telling you to buy are actually still buying. If they are, you might be friends with smart money. If they aren’t, they’re trying to get you to preserve their asset’s price – intentionally or not. The latter is called “talking your book.”
Prices rapidly escalate, until the asset hits a “new paradigm.” The world will now revolve around this limited product, that only a few people have. After all, they only make so many Beanie Babies. Cash is obsolete, now that we have Bitcoin and central banks can’t devalue your holdings at will. There’s only so much land in Vancouver, and everyone wants to live there. Everyone thinks their asset is the best in the world, and it’ll never adjust for prices. Deal with it.
Prices rapidly escalate here, moving almost vertically.
The blow-off phase is when prices start to fall – first a little, then a lot. After the initial fall, denial starts to occur. How can this be? The media parades “experts,” a.k.a. sellers of the product, to explain things have stabilized. The denial brings a newer, smaller round of money, working on the assumption of relative value. “It’s so much cheaper than last year,” is usually what they’re saying and it bumps prices a little higher. Traders call this a dumb money rotation – smart money’s last chance to liquidate. Buyers here call it the “new normal,” and think things have recovered. After all, it can’t get worse – right?
Only so many people are sold on the new normal though, and once you run out of them – prices resume falling, except much faster. Everyone that “needed” to buy, has already bought. Worried owners worried about their excessive allocation panic sell, triggering larger sell offs. This capitulates prices lower than fair value, assuming the asset still has value.
Prices begin to fall very quickly here.
This is the most interesting phase in my opinion, but it’s usually when the media stops covering it. You stop seeing flipping segments on daytime TV, the news glosses over it. The majority of people don’t want to hear about how bad of an investment they just made. “You can’t talk about Bitcoin/Beanie Babies/Real Estate every day!”
Smart money begins trawling through the mess, and determining if recovery is possible. Sometimes it’s dead money, like Beanie Babies – which have a slim chance of hitting their old peak. Sometimes it’s a gamble, like crypto. Smart money seems a little crazy here, like Mark Yusko raising money for an institutional crypto fund last week. If the asset still has legs, the cycle repeats as smart money starts scooping up more and more. It’ll either be a huge payout when they sell it back to middle class people in a few years, or they’ll lose a ton. The important thing is, they’ll lose less than the bubble buyers.
Here’s what those phases look like in the classic chart.
Phases of A Bubble
The phases of an asset pricing bubble.
Source: Prof. Jean-Paul Rodrigue, Hofstra University.
Now I’ll leave you with this chart of Toronto real estate. Where do you think we are?
Greater Toronto Benchmark Price
The price of a “typical” composite home across Greater Toronto.
Source: TREB. Better Dwelling.
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