## Thursday, January 12, 2012

### The Soft Landing Platitude

Much talk about a so-called "soft landing" of house prices -- where prices do not significantly fall on an annualized basis and incomes and rents increase to return valuations historical affordability or earnings ratios -- has been around recently with various banks warning markets like Vancouver's may be in for a large correction.

To test what would be required to manifest a "soft landing" I have taken the July detached benchmarks from 1999 until 2010 and adjusted them for inflation. Then taking the July 2011 benchmark as a baseline, determined what annualized % gains or drops would be required to return prices to previous years' inflation-adjusted valuations. I have assumed 2.5% annualized inflation.

In other words: what annualized gain or loss would be required to return prices to a given past year's valuation in a given future year? The results are as follows:

The way to use this chart is as follows. Say you think (or hope) prices will return to a certain past year's valuation (year Z) some point in the future (year X). Find year X on the x axis of the above graph and then find the colour of the past year Z of interest to find out what annualized gain or loss is required for that condition to happen.

For example say I want to know what annualized drop is required to see 2004 prices in 2018. That would require a compounded 4% drop in prices starting 2012 until then (i.e. 4% drop from 2011 to 2012, 4% drop from 2012 to 2013, etc.). For a \$800,000 property that means its value will be nominally \$626,000 in 2018.

(The base condition of 2011 valuations is a straight line because if one assumes 2011 is the "new normal" then prices will appreciate each year at the inflation rate. Thus, for 2011 valuations to hold in 2012, there should be a 2.5% increase year-over-year.)

I have included the absolute price change graph as well for completeness. Many people will look at absolute, not annualized, returns so here you go:

I don't know exactly how pundits define "soft landing" but whether they realise it or not they are hoping that more recent prices are indicative of new valuations. If it turns out inflation-adjusted prices from years closer to the turn of the millennium are the end destination, as they turned out to be in many parts of the United States, I'm not seeing anything approaching a "soft landing".