The real problem with Vancouver's outrageous house prices - Econowatch - Macleans.ca

The real problem with Vancouver's outrageous house prices - Econowatch - Macleans.ca

Bank of Canada - Working Paper on Housing Prices, Turnover and Bubbles

Thought this was an interesting read:  http://www.bankofcanada.ca/wp-content/uploads/2012/02/wp2012-03.pdf

This paper develops and estimates a model to explain the behaviour of house prices in the United States. The main finding is that over 70% of the increase in house prices relative to trend during the increase of house prices in the United States from 1995 to 2006 can be explained by a pricing mechanism where market participants are ‘Fooled by Search.’ 
Trading frictions, also known as search frictions, have been argued to affect asset prices, so that asset markets are constrained efficient, with shocks to liquidity causing prices to temporarily deviate from long run fundamentals. In this paper a model is proposed and estimated that combines search frictions  with a behavioural assumption where market participants incorrectly believe that the efficient market theory holds. In other words, households are ‘Fooled by Search.’ Such a model is potentially fruitful because it can replicate the observation that real price growth and turnover are highly correlated at an annual frequency in the United States housing market. A linearized version of the model is estimated using standard OLS and annual data. In addition to explaining over 70% of the housing bubble in the United States, the model also predicts and estimation confirms that in regions with a low elasticity of supply, price growth should be more sensitive to turnover. Using the lens of turnover, a supply shock is identified and estimated that has been responsible for over 80% of the fall in real house prices from the peak in 2006 to 2010.

Greater Vancouver Market Snapshot January 2012

Below are updated sales, inventory and months of inventory graphs for Greater Vancouver to January 2012. (The blue dots on the left of the graphs represent January 2012.)

And the detached benchmark price:

Commentary: January 2012 saw rather weak sales volumes. Months of inventory (MOI, the number of months it would take to clear month-end inventory at current monthly sales levels), a key indicator of market liquidity and impending price strength, is at about 8, a level concomitant with falling prices.

Total inventory went on a tear, recording the largest monthly gain in recent memory, most listings predated Chinese New Year, one assumes many listings were advanced to hit the real estate press in time for the two-week-long holiday, now nearly complete.

Below is the predictor of price gains, based on half-over-half price change to months of inventory correlation, and below that the scatter plot showing the raw actual data:

What this shows is the change in prices in a month from 6 months ago based on actual data and “predicting” the price based on months of inventory from that month based on linear regression of half-over-half price change to months of inventory (with 3 month moving average).

January 2012 was weaker than most past years (2009 being the glaring exception) in terms of sales and growing inventory. Due to several factors -- higher prices, relatively subdued population growth, tightened credit conditions, and a predicted increase in dwelling completions -- I expect the next several months of 2012 to see lower sales volumes and higher listings than 2011. I do think benchmark prices will increase from current levels through the first half of 2012 but prices are a lagging indicator of market distress. If inventory continues to increase and sales remain subdued, however, I anticipate the price increases will be transitory.

CMHC Tightening

I have been calling for further loan tightening being ordained by the federal government. CBC seems to be able to easily quote Mr. Flaherty while he's on tour:

Finance Minister Jim Flaherty said he shares the concern of Canada's top banking regulator that lenders are loosening their mortgage standards too much, but said any problems in the system are being corrected...
"OSFI's concern arises out of some work that OSFI has done as part of the ordinary course of its business to look at some of the loans being made by financial institutions," he said. "I was informed of what their assessment showed with respect to a few financial institutions, which is a matter of concern."
"That is being corrected," Flaherty said.

As I have mentioned in the past, further tightening amounting to reduced access to loans or faster amortizations seemed to be a shoo-in, now we are getting hints that the government is very concerned about debt levels and systematic financial risks, and will ensure they do not become worse than they already are.

This is akin to the previous explicit announcements on CMHC mortgage insurance qualifications announced in previous years. This year, it appears, guidance from OSFI and implementation of Basel 3 accounting practices -- not to mention higher prices -- are going to act as a brake on housing activity in 2012.

From the Canadian Press

Canada will likely avoid a crash or serious correction in its “somewhat pricey” housing market, with the possible exception of Vancouver, says a new paper from the Bank of Montreal.
The analysis by BMO economists suggests alarms about Canada’s housing market by international observers, from the International Monetary Fund to The Economist magazine, are exaggerated or simplistic.
“The main takeaway is that the national housing market appears somewhat pricey, but is far removed from a bubble,” said economists Sherry Cooper and Sal Guatieri in the report released Monday.
“In our view, the (market) is more like a balloon than a bubble. While bubbles always burst, a balloon often deflates slowly in the absence of a ‘pin’.”
Even Toronto’s hot condo market–one of the subjects of many of the warnings–is more likely to cool rather than collapse, BMO said, noting that a sharp decline in construction for rental units is stimulating demand for condos.
The report estimates that half of new condos in the Toronto area are purchased by investors, and about 22% are rented.
The one exception to the sanguine view appears to be Vancouver and parts of British Columbia, where home prices and demand from an influx of non-resident Chinese investment is elevating prices and construction. Home prices in Vancouver have climbed by 159% over the past 10 years, more than 50% higher than the national average.
“Bottom line is, we expect the Canadian housing market to cool down rather than bust over the next couple of years, with the possible exception of Vancouver and parts of B.C. which will likely experience further correction,” said Guatieri in an interview.
By cooling, he predicted that prices, sales and start-ups will essentially be flat this year and likely next.
Housing has become an area of concern for policy-makers over the last few years as Canadians continued to dip into the mortgage market to take advantage of historically-low interest rates. As a consequence, household debt to disposable income has shot to over 153%, the highest in ever and close to the levels reached in the U.S. before the subprime crash.
Earlier in the month, Finance Minister Jim Flaherty said he was prepared to intervene for the fourth time in six years if there is no let-up in borrowing.
The BMO economists say the government, and the Bank of Montreal, are correct to worry about a continuation of the trend, but that is not likely. In fact, except for a few hot spots, that cooling trend has already begun with prices rising only by 0.9% last year. Home starts have also dipped well south of the over 200,000 level.
Nor is it likely that Canada will fall into another recession, or that interest rates would rise so quickly that a significant number of households would be unable to meet mortgage payments.
Canadian households are not as vulnerable as their American counterparts, the economists say.
Canadian home ownership equity is 67% in Canada, compared to 39% in the U.S., and even debt-to-income ratios are far better in Canada when the cost of health care U.S. households must pay is factored in.
The report argues that many of the measures used by alarmists to suggest housing is due for a severe correction are exaggerated or simplistic.
On the important measures which gauge affordability, households are on firm ground. House prices to family incomes are elevated from 10 years ago, but not excessively so, at a ratio of 4.9 versus 3.2 a decade ago.
The exception again is Vancouver at 10, nearly double what it was a decade ago. Also elevated is Toronto at 6.7 versus 4.3.
“Let’s assume the worst case scenario and house prices fall by 10%, would that affect anything?” asked Guatieri. “There has been such an increase in house values, that I don’t think it would pose a serious problem for Canadians or the economy.”
Guatieri said the situation would become a problem if home prices and household debt continued to outstrip income growth, but trends on both fronts are moderating.
Originally published on Advisor.ca

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