Canadian real estate went from the narrative prices will always rise, to “look out below” in a matter of weeks. It’s not surprising to see a fickle public change their mind that fast, but it’s odd to see the Bank of Canada (BoC) do it. In the House Price Exuberance Indicator (HPEI) for Q1 2022, they warn “most” major markets have become exuberant. Exuberant markets are better known as bubbles to common folks like us.
What The Heck Is Exuberance?
For those only vaguely familiar with the term exuberance, let’s spend a second on what this means. Exuberance is a state of excitedness, usually leading to the dismissal of any and all risk. When you’re excited about something, nothing’s going to stop you. It’s a great idea when it comes to buying donuts at Machino’s but not so much for the biggest purchase you’ll ever make.
Ever since Alan Greenspan used the term in 1996, at the suggestion of Schiller, it’s caught on. It’s now code in economics for “bubble,” and it’s a lot less panic-inducing. Saying, “that market is a bubble” creates fear and makes people defensive. Now if that market was just “hella’ exuberant,” it sounds a lot more ambiguous.
Bubbles are tricky — you never know how long they’ll last and you don’t know if policymakers will delay a correction. At the same time, they’re fragile. The only thing between the market price and fundamentals is how people feel. Emotions can ramp down just as quickly as they ramped up, as exuberance turns to fear. Negative economic shock doesn’t have to hit, just the feeling you can no longer cheat death has to arrive.
The House Price Exuberance Indicator (HPEI)
The US Federal Reserve has tracked exuberance in the Canadian real estate market for almost a decade now. After years of us teasing the BoC about the US knowing more about Canada’s real estate than them, they gave it a shot. Last year the House Price Exuberance Indicator (HPEI) was released, the BoC’s very own creation.
Just like the Fed’s exuberance index, the HPEI looks for explosive price dynamics. These are price movements in excess of fundamental reasons. Fundamentals are things like income and mortgage rates. Fundamentals are not your cousin Jimmy saying he heard at the gym that real estate is gonna moon forever.
The acceleration is measured as an index score and color coded to make it super easy. Stable markets are green, heating up markets are yellow, and red is an exuberant market. Everything between is the transition between stages, with darker colors meaning the sentiment is stronger.
BoC Warns “Most” Major Real Estate Markets Now Show Exuberance
The BoC warns “most” large cities are showing exuberance. The last update to the measure was in Q3 2021, when Hamilton and Montreal were the only bubbles. In Q1 2022, Toronto, Vancouver, and Ottawa join them. It might be hard to believe, but the BoC didn’t consider Toronto a bubble while it was topping global lists. Suburban prices even climbed up to 60% and didn’t raise a warning sign. Gotta be fundamentals, I guess?
The central bank notes, “… these indicators were collected before the slowdown in housing activity and price growth in April. It remains to be seen whether data for the second quarter will support the same conclusion.”
Sweet. It’s been hours since the home prices stopped rising tens of thousands per month. Obviously the problem might have solved itself in just a few weeks. In just over a year, the BoC went from saying “we need the growth” to flagging “most” real estate markets as exuberant. Why wouldn’t the issue possibly be solved almost immediately? Sounds like someone is warming up to explain the bubbles were transitory, just like inflation.