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You Had Questions About Canadian Real Estate Cycles, So Here’s Some Answers

You Had Questions About Canadian Real Estate Cycles, So Here’s Some Answers

Over the past week we got an usual number of questions, about a piece I wrote last week. The article focused on Canadian real estate cycles, and was based on some things I said as a guest of the Toronto Association of Business and Economics (TABE) and Ryerson CUR. Instead of responding to them one by one, I’m going to bulk together some of the most frequently asked questions, and answer them in a Q&A format. Here we go.

These real estate cycles are based on 100 year old observations. Don’t markets change, making it useless to predict them?

Henry George did the original observations, but the market cycle theory has been refined greatly over the years. San Francisco based Professor Fred E. Foldvary, built on Georgist observations, and most famously used them in his 1997 paper, The Business Cycle: A Geo-Austrian Synthesis. In the paper, he explains that the US real estate cycle would end around 2008, based on the business cycles. He also explains that a major interruption to business, like a major war, could be a delaying factor, but won’t stop the cycle. He was pretty dead on with that call.

The cycle theory was also refined by Dr. Glenn Mueller, who authored the textbook Real Estate Finance. It’s essential reading for many MBA programs dealing with real estate finance, and for good reason. He’s the person that broke down volumes of Georgist theory into the easy to consume four stage cycles we use today.

Canadians have largely depended on the analysis of “it always goes up,” but as we can see from previous decades, that’s not always the case. We’re just forgetful when it comes to remembering the down cycles, and over emphasize the upswings. International real estate investors, and even local developers, understand and still use these cycles in the market.

People Like You Have Been Calling For A Crash For 30 Years. Why Should We Believe You Right Now?

First of all, I don’t recall saying anything about real estate 30 years ago – probably because it wasn’t a hot topic on playgrounds. Second, I’m not discussing a market “crash,”  I’m discussing a downcycle. A downcycle isn’t necessarily a crash, it’s a reduction of prices. Businesses receive down cycles, and this impacts the wages people get, and how much they can afford to pay for shelter. People aren’t perfectly rational all of the time, so there’s going to be some exuberance, especially when people are blinded by the fact that they can make money.

Now, with regards to Toronto and prices. Toronto didn’t have a 30 year bull market, it took until 2008 to recover from the 1990s downcycle. If you bought in 1989, the inflation adjusted value wasn’t realized for 22 years. Even up to 2015, I would say Toronto real estate was fairly valued. Prices can’t go up every year forever, and you certainly aren’t going to be able to get a 9% return every year. If that were the case, a $950,000 condo you bought would be worth over a billion by the time you die. If that’s the case, you don’t want to be someone holding Canadian dollars.

You Had Questions About Canadian Real Estate Cycles, So Here’s Some Answers - Chart
A satirical chart made by a Vancouver based equities trader. 

Is there anyway to avoid a recession?

People tend to think of recessions as scary, so politicians try to kick the can down the road for as long as possible. Polina Vlasenko, a senior researcher with the American Institute for Economic Research (AIER), points out these are necessary to correct the mismatches in the economy. She argues that the longer you extend the service of these mismatches, the more severe the recession will be. Instead, she suggests “Your [the government’s] goal shouldn’t be eliminating recessions. You goal should be helping people get through them with less damage.”

Basically we can delay them, but the greater the delay the worse the mismatch of resources grows. The worse the mismatch, the worse the recession. The reason Better Dwelling reports on these types of things is so millennials, governments, and investors can learn to minimize these mismatches in the future.

Toronto Doesn’t Have Very Much Resale Inventory. Won’t Prices Have To Continue To Climb, Making It A Longer Expansion Phase?

Inventory is a funny thing, it tends to magically appear as soon as prices start falling. Southern California, specifically Orange Country, is a great example of this. Inventory fell to just 1.2 months of inventory in 2005, right when the market was scorching hot. That’s an extremely tight market, and people are expected to pay steep premiums if they “need” a house.

By 2006, prices started falling due to the fact it was very hard to support prices at those levels. Inventory magically soared to over 9 months, an extremely cold market. Did Orange County suddenly stop being a desirable place to live? No. People that were holding onto properties were waiting for the “top,” in order to sell. If you have an opportunity to make a ton of money, people are going to speculate – especially when locals are hyperfocused on ownership. It would be stupid not to buy a few condos to sell to people if you think they’ll appreciate 9% per year. Figuring out where the top will be is never easy however, and this tends to lead to a sloppy race to liquidate first.

How Is It Possible Toronto Is In A “Hypersupply” Phase, Since Completions Are Very Low?

Completions aren’t low, they’ve been steadily climbing. At the end of October the CMHC counted 31,994 completions in Toronto, an 11% increase compared to the same period the year before. The CMHC counts 70,000 units currently under construction, which means building has begun on the foundation. The CMHC also counts an average completion time of 20.6 months in the city of Toronto, so we’re going to see these start to hit the pipeline soon.

Source: CMHC.

There’s also growing evidence from notable housing researchers to suggest developers are discount bulk selling condo pre-sales overseas. Not because they’re supervillains looking to sell them to evil foreign investors, but because it’s getting harder to sell all of these units domestically in the required time frame to finance the project. The window they have to secure financing for these projects isn’t very large, and the profit margins with land this high aren’t as lofty as people think. This means prices do need to come down for locals, but who’s going to take the loss? Developers don’t want to take a loss, the investors they sell to don’t want to take a loss. Most people are pretty foggy on who lost money during the 1980s condo boom, but here’s a little hint – there weren’t a lot of developers and financiers that lost their shirts.

Is Toronto Overbuilding?

Overbuilding for what? I don’t think we’re at the point where we need heavy restrictions on supply. I also don’t think we have an emergency where permit times need to be dropped either. The city of Toronto has some really great planners, and they do an awesome job at approving supply for the most part. Are we overbuilding to preserve prices where they are? Yes. That’s a good thing however, it means the city is getting closer to a correction – which once again isn’t a bad thing. It’s how we clean house to make markets more efficient.

Canada Is Targeting 350,000 More Immigrants Per Year. There’s Only Two or Three Cities They’ll Move To, Won’t This Make Housing Scarce and Therefore Push Prices Higher?

Those moving here for a better opportunity tend to taper as the economic outlook worsens. Looking at a chart of immigration and recessions, you can definitely see this trend evolve. Immediately after a recession, we see that the number rises – these are the people that applied on the upswing. The few years after the recession tends to see numbers taper, as less people find it unappealing to move to a place with high home prices, and little opportunity. The assumption that economic conditions can continue to worsen, but immigrants will continue to pile in is kind of dumb to say the least.

Source: Government of Canada, Better Dwelling.

Now, there’s one class of immigrant that won’t be impacted by this – those planting flags. A person I know is a specialist at legal offshore diversification, and Canada is number four in his list of countries to get a passport. These are people looking for lower tax jurisdictions, not necessarily productive immigrants. I think of these as passport sales, the government is just happy to keep the numbers higher. That’s a different problem, but not something that will necessarily continue to happen. You get the same passport buying a house in Halifax as you do buying a place in Toronto.

Should I Sell My Home Right Now?

We get this question at least a few dozen times a week, but last week it got out of hand. We don’t offer personal advice, sorry. For that, you should go to a fee-based financial advisor, and see what they have to say. Note, fee-based, not the free one at your bank that gets a cut of commission from everything you buy. Some of the bank ones are decent, but it’s hard to figure that out because their motivation is to sell you an investment – not make you money. Before doing that however, you should think about the following.

If you’re selling your primary residence, where are you going to live? Some people end up renting a place that was the same cost as their old mortgage, and that’s a little silly. Renting is a great idea, but you can’t spend more than the cost of interest on a mortgage for a comparable sized home — otherwise, you’re losing money. If you can live with a rental for the cost of interest you were paying, it becomes a decent decision if you’re investing the principal in some other way.

If you’re selling an investment property you have, that’s a different story. You won’t be able to sell at the top, unless you’re extremely lucky. There’s no way to predict how exuberant people will be, including yourself. You unload assets when you feel the risk to your portfolio is too high for the future return. Balance your portfolio beta. If you don’t know what that means, get on booking that advisor appointment, or prepare for a lot of reading.

“When beggars and shoeshine boys, barbers and beauticians can tell you how to get rich, it is time to remind yourself that there is no more dangerous illusion than the belief that one can get something for nothing.”

―Bernard Baruch, American financier and advisor to the US President during both World Wars.

Should I Buy Now?

You should buy when it’s right for you. That means you can afford it, and you want it. If you’re buying as solely an investment, pretend you’re the tenant. How much would you pay for a comparable sized property? A fund manager I spoke to said he’s renting these days, and he estimates it would save him about $50,000 per year vs buying the same property. $50,000 can buy a lot of other investments, and he gets to live in pretty much the same home he would have bought. It doesn’t always make sense, but at the same time – it doesn’t always have to. Just make sure you’re not convincing yourself it should be your primary investment.

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4 Comments

  • Reply
    Alistair McLaughlin 2 weeks ago

    “Your [the government’s] goal shouldn’t be eliminating recessions. Your goal should be helping people get through them with less damage.”

    Unfortunately, such an attitude would be attacked as heretical and “heartless” if uttered by a politician or policy maker nowadays, by both the left and the right. Lefties can never have enough “stimulus” in the form of government spending. Righties too love their “stimulus” – even if they won’t call it that – in the form of tax cuts. In fact, regular recessions every 5 – 8 years are not only healthy, but necessary. They help reduce distortions, resource misallocations and excessive leverage and risk-taking and leave the economy on a more stable footing.

    I’ve always felt that the government’s role during a recession should be palliative as opposed to curative, or worse, preventative (i.e. cranking up spending even before a recession in order to stave one off). Help people muddle through the recession as best as resources allow you to, but for gawd’s sake do not spend a massive amount of money trying to “end the recession”. The recession will end when it ends. No government gets to decide that. Economic cycles can only be distorted. They cannot be tamed or defeated. Find me a politician who admits that and says so out loud, and I’ll vote for them. Sadly, I’ll be the only one.

    Keynesianism has become gospel. Keynes came up with his policy prescriptions at a time when government spending was 5% of GDP. There’s no way a brilliant man like Keynes would have maintained a steadfast belief in the effectiveness of “stimulus” as he watched government spending rise past 40% of GDP and in some western nations – 50%. I’m quite convinced that were he alive today, he would disown modern Keynesians – every last one of them.

  • Reply
    Tim 2 weeks ago

    Stephen, I am a big fan and loyal reader.

    You forgot one VERY important metric. Fraud. As in all cycles, the f word tends to be more prevalent near tops……I’m sure you have been following the fraud allegations against Fortress? Home Capital? Syndicated mortgages? Bank lending practices. Do you follow CREA and the provincial real estate boards. They do list names of agents who have been reprimanded/charges/fined. I would argue fraud peaked last year……fraud charges/allegations peaked in the U.S about 2 years before things became unraveled. Big Short firmed that up. The U.S also blamed immigrants for the run then too, and were left holding the bag no? sound familiar…. As a Canadian I am embarrassed as to how housing has become such a lust and topic of conversation…..

    • Reply
      Michael Z. 2 weeks ago

      Fraud is a side effect of too much incentive. It tends to bubble up when people think there’s a lot to gain, and little downside. Which ends up creating more risk.

      I love my house, but there’s no way I would have paid someone to doctor papers to afford it. I also wouldn’t spend more than I can afford on it. I enjoy it like a consumable, and if it’s worth more when I sell – awesome. If not, oh well.

  • Reply
    Justin Thyme 1 week ago

    It’s a down cycle when your neighbor looses their home.

    It is a crash when you loose your own home.

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