Friday, December 26, 2008

Opening the bottom window

I am no more able to tell you precisely when the housing market will bottom than I was able to tell you when it would top. But, I have strong faith that at some point prices will begin to rise again.

I fully expect to see the regular CMHC/Bank/Etc. local RE pumpers telling us that a price recovery is right around the corner. We will hear this every single month of the drop. But let's ignore their self-interested and delusional chatter.

As I said above, pinpointing the exact date of turnaround is not a productive exercise because I have no clue what will be the state of interest rates, employment, incomes, and other fundamental factors that will be important. For example, imagine that speculative excess has been squeezed out of the market by the end of 2010, but at that point interest rates start to rise as the US/Canada pull out of the recession. That would push the RE market down even further, most likely. But maybe we'll be ZIRPing for a decade like Japan. I don't know and I don't care to guess.

What I'm really interested in is trying to figure out some cues for when the 'window to a bottom' might open. Three things come to mind.
  1. End of the Olympics.
I think that it is not possible for speculative excess to be squeezed from the market until those who are expecting the Olympic fairy to revive our local RE market finally see that this is simply fantasy. For the last few dead-enders, it won't clearly be fantasy until after the Games have left town. (And even then, I'm sure the pumpers will be telling us that it's a long-run thing and that we shouldn't have expected an immediate boost. Ha!)

So, no bottom until at least March 2010. I like this metric because it is a definitive date we can work with. But I think March 2010 is too soon for a bottom to form, so let's think of other measures.
  1. Tightening of credit availability.
Credit will become much tighter. Anecdotally, we have heard that it is harder to get mortgages than it was a year ago. However, I expect things to become much tighter. See this post from CR, for example. Rates are low, but few qualify. We'll see higher required downpayments, more secure employment and income, and no more phantom suite income. Until credit availability tightens up, there will simply be too much fantasy buying with OPM. The window to the bottom will open when people actually have to start buying with their own money again.

The disadvantage of this metric is that I can't think of how to quantify it. So, it is hard to use this a rule to call the bottom window open. Conceptually useful, but practically difficult to implement as a decision rule.
  1. Under construction falls below 10K.
My favourite measure that I'll be watching is 'under construction.' See Mohican's most recent post on starts/completions/under construction here. We have blown through historic highs for this measure; almost double previous highs. This has two important implications.

On the demand side, this has meant a lot of employment and income for the construction and related trades. If under construction drops, so will employment and income. Fewer renters for condos, and fewer buyers.

On the supply side, this huge amount of units under construction makes for a very large overhang of supply. With this huge overhang comes price competition among sellers. With 20 or 30 sellers competing for each buyer, prices will fall quickly--and can even undershoot fundamentals until the supply overhang is worked off. (Undershoot fundamentals? That would be cool to see . . . but I think it possible.) Also on the supply side, some of the laid off construction workers will go BK or into foreclosure, making the oversupply problem worse.

So, putting the demand together with supply, I predict that the coming big drop in units under construction will have a very negative effect on prices. It is only when this tsunami of supply and massive demand shrinkage finishes that we can begin to talk about the bottom window opening.

OK, so at what level will 'under construction' bottom? Don't know. In the US, CR tells us that starts are at the lowest since 1959. I'm just going to do a WAG based on Mohican's chart. I am fairly confident that we'll go back below 10K, as we always have after each boom. On the balance of probabilities, I think we'll see us go down to 5K. But I don't want to set up a decision rule that has a 50-50 chance of missing the bottom. So, I'll choose 10K under construction as my 'it's time to start talking about a bottom' indicator.

Questions for the readers:

A. What is your preferred indicator that the bottom window is open? Let's confine answers to things that are quantifiable, rather than anecdotal indicators.

B. What do you think of the 'under construction<10K' indicator?


jesse said...

I'll go out on a limb and say the bottom won't be in until the savings rate definitively crosses zero again (in the + direction). The process of deleveraging and saving is the antipode of leveraged speculation. Once the savings rates are sustainable, prices should be back to sustainable as well.

Construction IMO is a hard one to gauge only because the units being produced in this boom are smaller than before. A better measure would be bedrooms under construction. Also there are always dormant units that can be commissioned to fill demand (as can flat sharing). Below 10K is probably as good a guess as any for nominal bottom.

Why not use cap rates?

Unknown said...

I'm not sure about the exact bottom, but I'd start being interested when months of inventory start shrinking back to < 10 months. You'd still be well within a buyers market, but I'd say its a market in recovery. If you're trying to get in during that point where the market undershoots fundamentals and fear reigns, then I'd look at average rental rates. Personally, I don't track this, but its seems to me to be the best way to track RE market fundamentals.

mohican said...

I am looking for completions to exceed starts for 24 months. Once starts start to outpace completions again, we will know that the bottom is likely in or a close enough approximation. Additionally, I will continue to look at the existing home months of inventory for a clue. When MOI drops below 8 in the spring selling season I'll know that we are in a more normal market with buyers still having the upper hand.

sluggo said...

I would expect as much speculative froth to come off the RE market on a % basis as the rest of the capital markets worldwide as easy credit filled every balloon to the max equally.

The current exit and massive asset deflation will take the air out of everything and we're just seeing the beginning in the lower mainland. Just wait until all the owls show up and the only thing the sellers hear is 'To who, to who'.

All the major global indices have retraced back to their 1998 levels and some would suggest they are still overvalued and headed lower.

With historically low interest rates, the spread between the over night rate and 5 year posted rate is increasing as banks are becoming more and more reluctant to hand out money.

While the OJ's and Renney's of the world pump away into the void with the 'buyer's market' hype, inventories sit amongst developments where subcontractors are being forced to roll back prices as giant holes slated for elevator cores and under ground parking are filling with Vancouver's biggest ever snowfall, soon to melt and put everything underwater.

John Collison said...

The bottom will be well and truly in when NOBODY is talking about real estate any more. This IS quantifiable. I mean NOBODY. No more reality shows, not even re runs. Home and Garden has changed formats. That sorta scenario. The bottom will be in when nobody is talking about the bottom being in. The point of utter, psychological exhaustion.
And for fun, I predict we see this circa 2011 (coincidentally two years after the most reliable US bears call the American bottom); and it will be a long, languishing bottom, perhaps another five or six years until MODEST price appreciation kicks in again. Another peak? No earlier than 2020.

Rob said...

To further Octagonian's thoughts, I think an important psychological marker of a bottom will be maximum loss of confidence in the asset class.

An example would be reliable survey data indicating historically high levels of agreement with a statement like, "Real estate is a poor investment." (Or something a decent pollster might come up with.)

jesse said...

"The bottom will be well and truly in when NOBODY is talking about real estate any more."

That's all some families talk about. Without real estate conversation I wonder what will fill the void.

james-wong said...

Further to Valuemonekey's comment, the housing market bottom can be gauged quantitatively by following the supply/demand ratio. The bottom should be around 6 months list/sale ratio. Presently, Greater Vancouver home supply/demand is over 12 months supply.

As happened in 1994/95, the housing cycle hit bottom around 1998. You can view the graph here (last page of REBGV average price graph). This will take 24 to 36 months to play out if the same cycle is repeated as for the peak for 1994/95.

This time around, there are more uncertainties like credit tightening, affordability problem and uncertain interest rates situation after the market recovers.

macho slob said...

After the tiresome gong show on RET, it's nice to find some thoughtful replies to an interesting topic. I'm also glad to see that more people are accepting the fact that we could see a very long bottom.

I've felt all along that the continued uptrend of our market long after US markets peaked was totally irrational and that our crash would be sharper by playing catch-up....that seems even more likely now, with the collapse of the global economy.

I would not be surprised to see the true bottom in 2009, with fear and panic causing the market to overshoot on the downside, and re-test those lows several times and languish for years.

Previous recessions tell us that stock markets always sniff out the bottom well before housing markets, as homeowners are usually the biggest vitims of a recession.

After years of a long drawn out bottom, I think the recovery will be so mild that it will be anticlimatic.

Strataman said...

I would say when the statistical unemployment rate drops below 10 %. For a number of years we will see unemployment in the double digits. When it will return to the great 9% unemployment (it will make headlines) is when prices will begin to recover. By the way the real unemployment will be twice the stat ! My guess and that is all it is a wild guess; 2013

buff_butler said...

I am speculative of the new construction measure simply because this was quoted in edmonton and has since passed. I think with extreme inventories reduction in construction doesnt seem to have an effect because other forces are bringing the houses to market as well such as soon to be distressed sellers.

-I would watch inventory to drop to normal levels.

-Job creation I found to be a huge variable. Its tough to get an accurate source though.

-Watch for when the REITs start putting money in??

-Offering to Wanted ratio's on kijiji :P

condohype said...

This is the best comments roll I've come across in ages. Van Housing Blogger, you are a legend.

I'm a fan of the price-to-rent ratio as a leading indicator. We'll approach the bottom as prices fall in line with rental rates. I believe an undershoot of the fundamentals is a real possibility because of the broader economic situation. If we're in a deflation-oriented recession, which I believe we are, then asset values will have a very difficult time pushing upward. How long we stay in a bottom market -- that is, how long we scrape along -- will depend on how quickly the economy gets out the recession. I share Stephen Jarislowlsky's fear of deflationary recessions.

Cam Hui, CFA said...

I have used the rule of thumb that buying a property with 25% down and it carries itself. This is a variation of the price to rent ratio.

Based on current sales, which I am not sure truly reflects the market as sales volumes are so low, this suggests that single detached housing has 10-15% downside and condos 20-30%.

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