Sunday, March 21, 2010

Housing Bubble - - Yes or No

Canadian Housing Bubble by Alexandre Pestov at York University's Schulich School of Business.

Here is the abstract, click on the above link for the full meal deal.

The cause of the housing bubble associated with the sharp run-up and the subsequent drop in home prices in the US over the period of 1999-2008 has been the focus of significant research attention. Despite numerous similarities, the Canadian housing market escapes the same level of interest, mostly due to the seemingly stable housing prices.

This paper explores the subject of a possible housing bubble in Canada. It examines a diverse array of factors that may have contributed to the rise in house prices in Canada. The paper evaluates each factor individually and determines the health of the Canadian housing market using common valuation techniques.

Results suggest that economic fundamentals in Canada provide little explanation for the Canadian house price dynamics. Market fundamentals have become insignificant in affecting house prices, and the price-momentum conditions characteristic of a bubble now exist. The extreme decoupling of the market prices from the underlying fundamentals suggests an upcoming correction in housing prices in Canada.


Arwen said...

It really IS different in Vancouver, in terms of overvaluation. We were in 2004 where the rest of Canada is now: my house is at a multiple of 350!

JimTan said...

I gave up on Alexandre Pestov's The Elusive Canadian Housing Bubble after reading the first 13 pages. He presents nothing new.

He says that he is convinced after interviewing 30 owners that Canadians don't understand mortgages. That's the only original 'research' that he does. Compare that to the CAAMP analysis generated from their database.

He uses the affordability study done by RBC. He says that it is incredible that 70% of median income is needed to buy a SFH! Of course, people who buy SFH in Vancouver don't earn median income. The typical FTB buyer settles for a condo (by a coincidence 40% of median income). That's why the housing mix is changing.

The RBC study is only useful for comparing relative affordability between markets. Median income is not a useful measure of absolute affordability. It includes households that are not buyers and unlikely buyers.

The CAAMP study is very important because it shows that most people who actually buy are buying realistically and borrowing conservatively.

On the other hand, Pestov falls into the typical financial analysis trap. What's the intrinsic value of housing? Moreover, he doesn't consider the supply part of the equation. What price do landowners place on property. What's the supply response? Will housing starts exceed demand?

JimTan said...

FYI, Pestov has a diploma in engineering. He's a MBA candidate at York University. He's not a trained analyst. But, he hopes to join a management team!

AndrewJ said...

The CAAMP study is very important ...

You hang everything on one study by a group specifically interested in mortgage lending continued unabated? Seriously?

He makes numerous other points backed up by multiple studies such as:
- The reason the US went down and we didn't is because we still had a subprime market to tap which we are doing with abandon.
- We've simply delayed the problem and pushed it off to the future where it will be worse.
- People really don't understand how mortgage interest increases affect their downpayment. I found Mohican's 1% up in interest equals 10% down in housing prices (assumming that people are maxed).
- Zero down 40 year (and even 5% down 35 year) are essentially interest only mortgages. You add 10 or 15 years to your mortage for a couple hundred dollars a month.
- The fact the bubble reflated means it's not a bubble is a fallacy because to reflate it we've taken all our previous prudence and are burning it in a big bonfire.

If I have any quibbles it seems a little political for an academic report with quite a few spelling mistakes. Not sure if he is 100 percent unbiased because of the political comments. It also reads like a bear manifesto so yes he could have a bone to pick.

BTW 40 percent of gross median income for a condo is still really high. It just looks better next to single family homes. Also it's going to spike when interest rates go up as well. Since he is using the SFH to median income ratio for all markets it is still valuable to compare us to other markets. Does anyone know if the 9.3 ratio is based on average of all types of housing or just SFH?

In the end though I have never seen a single bull argument as well thought out and backed up by generic (non industry specific) stats. You say supply and demand and I say that the demand side has been unsustainably messed with. As soon as interest rates go up nobody will be able to pay current prices.

jesse said...

I would love to see the credentials of regular posters on this blog. Pestov's analysis isn't new because fundamental analysis has been around for hundreds of years. He is one of the few to actually apply it to Canada where other "experts" have not.

patriotz said...

Certainly people may have some doubts about price/income since both numerator and denominator are statistical abstracts.

No such doubts are possible with price/rent. That's a measure of the economic return of a particular property, pure and simple. And the fact is that price/rent is in orbit for every kind of property in Vancouver. They are all priced far above any credible estimate of fundamental value.

Notice that the people who use housing mix or other arguments to criticize price/income never refer to price/rent as an objective check. Never let the facts get in the way of a good argument.

jesse said...

Price-income is useful only because certain areas have very few equivalent rentals to get any useful data.

Declan said...

The other thing about price-income, is that a housing shortage (such as the ones in England/Australia) can drive up the price/income ratio without indicating a bubble, people are just spending more on housing (both purchase prices AND rents) because supply is restricted.

The price-rent ratio strips out this potential source of confusion by separating the speculative purchase from the unspeculative rental.

JimTan said...

"No such doubts are possible with price/rent. That's a measure of the economic return of a particular property, pure and simple."

Dear Patriotz,

I consider price/rent to be an unreliable predictor of the future. Rental income is only one of the factors that determine prices. Therefore, the price/rent ratio can change in a number of ways. Price can fall as you suggest. Prices can stabilize, and rent rise. Or, prices and rents can rise with rents rising faster.

As a market operator, I find that it is important to identify the key economic drivers. These critical factors allow me to reach a conclusion that is actionable. None of this stuff about 'I will be right eventually,' I have to reach a decision that can be implemented in a reasonable period of time. Anything else is just talk-talk.

Back on topic, Pestov's work is a commentary, not discerning enough to be economic analysis.

patriotz said...

Rental income is only one of the factors that determine prices.

Earnings (in relation to long term interest rates) are the only factor that determine asset prices long term.

All bull arguments in bubble markets are based on the assumption that fundamentals don't matter.

jesse said...

"Pestov's work is a commentary, not discerning enough to be economic analysis."

His credentials give him more than enough background to present a reasonable analysis. Even if his credentials were of an elevator operator at a hotel or a long-term resident at a mental institution, most of the analysis and all the data presented stand on their own, perhaps with a bit more pinache than the usual dry analysis we've been used to.

JimTan, after so kindly pointing out Pestov's credentials you have failed to disclose yours.

JimTan said...

Dear Jesse,

I don't know what you mean by pinache?​ What I expect to see at the post-graduate level is the ability is examine several POVs, and logically explain why you choose one course of action.

You won't get more than a Pass for compiling the work of other people. You will get a Credit if you can explain what's happening. For example, Mohican posted the price/rent chart for select OECD. Why are the price/rent ratios different for a number of countries? Is the price/rent ratio a reliable predictor of prices?

Meanwhile, we are going to see a test of the theory that we will have a collapse of house prices during a bull economy. The data suggest that we are on the upturn of the U-shape curve.

Durable Goods Orders Rise Slightly Less than Expected
Published: Wednesday, 24 Mar 2010
By: Reuters

New orders for U.S. durable goods rose for the third straight month in February as businesses rebuilt inventories by the largest margin in more than a year, pointing to continued strength in manufacturing.

The Commerce Department said on Wednesday orders for long-lasting manufactured goods rose 0.5 percent last month and January's figures were revised sharply upward to show a 3.9 percent increase.

Markets had expected orders to gain 0.7 percent in February from the previously reported 2.6 percent rise.

"This shows the strength in the manufacturing sector. You already created manufacturing jobs in January and February. We are at the cusp of creating jobs in the rest of the economy," said John Canally, economist at LPL Financial in Boston.

EI beneficiaries fall 6.4% in January

Financial Post
March 24, 2010

The number of people receiving regular employment insurance benefits fell in January for the fourth straight month, with declines recorded in every province, Statistics Canada said Wednesday.Photograph by: Mark Blinch, ReutersOTTAWA — The number of people receiving regular employment insurance benefits fell in January for the fourth straight month, with declines recorded in every province, Statistics Canada said Wednesday.

There were 698,800 EI beneficiaries during the month, down 47,700, or 6.4 per cent, from December, the federal agency said. The biggest declines were in Ontario, Alberta, British Columbia and Quebec.

"With the decrease in the number of beneficiaries since June 2009, more than a third of the increase that took place between October 2008 and June 2009 has been offset," the agency said.

Meanwhile, initial and renewal claims totalled 239,100 in January, down 20,200 from the previous month. The declines were recorded in every province except Newfoundland and Labrador, with Ontario posting the biggest drop, down 8,200).

"The number of initial and renewal claims received has been on a downward trend since May 2009, with declines in every province," Statistics Canada said.