The Toronto Housing Market: A Boom-and-Bust Theory
A good friend of mine who’s a hockey player just sold his house in Toronto. I decided to uncork a bottle of wine that I saved for 20 years to celebrate with my old friend. As children we were always at the local rink playing hockey together, what we didn’t know is that we were building a bond at the time that would align our interests for years to come.
He was a little discombobulated when he came over to my place. I opened the bottle and we sat down, looking across the backyard and reminiscing in old memories. He told me he was a little pissed off with the real estate agent. He sold his house for $1.5 million assuming that he was getting a great deal in view of the fact that he paid $210,000 about 25 years ago.
The problem however is that he now has a $550,000 mortgage at the ripe age of 57. However, this didn’t stop him from looking at the home he previously owned that was sold 2 months later for a handsome sum of $2.1 million. He was livid and cursed the agent for what he believed was a scam. He felt that if he sold his house 2 months later he would’ve been free and clear of any outstanding mortgage.
I was intrigued not only by the evaluation, but also by the actual paradigm that exists between real value and market forces that have circumvented the supply to reap huge capital gains for any individual interested in selling.
It’s difficult to summarize whether or not the Toronto real estate market is indeed in a bubble. If housing prices are not sustainable then current demand levels suggest that sales should in fact be stronger, which is what is beginning to happen. But there may be a different scenario at work here involving the notion that individuals searching to buy a house in the realm of affordability are only now in the quagmire of multiple bids because of a lack of supply.
One has to examine a real estate agent’s social dynamics in the market to illustrate a clearer picture of this fiasco. By assessing an agent’s priorities to persuade others of current trends, markets have shot up based on a word-of-mouth strategy that plays on people’s beliefs on bigger returns if they sell now.
However the reality is that when agents are skeptical of the real estate market, they are also usually right. Typically, the booms that are followed by busts lead agents to become more optimistic and influence their predictions in becoming true. The rising Toronto housing market established the paradigm based on the perceived notion that the purchaser was able to borrow against rising house prices and a mortgage market that was very fluid in believing that concept.
New housing construction becomes profitable when house prices rise above housing construction. However the prices of property movement on new construction need to continue to accelerate in order to reflect the rise of price development. A significant real estate boom relies on the unsustainable easing of mortgage credibility standards. If Socrates was alive today, he may have asked for the justification explaining how the delicate balance of raising and lowering interest rates may not be enough to moderate current real estate boom-and-bust cycles.
Monetary policy feels secure in interpreting excesses and weaknesses in the housing market by manipulating interest rates to iron out the business cycle. However interest rates will fail to alter the psychology of someone that believes they have paid too much for a given piece of property and have thus incurred an escalation of debt that will effectively affect their consumption decisions.
When house prices become unaffordable, house prices will plummet dragging the rest of the economy to the cellar along with it. The housing market’s fatal weakness or achilles heel is not primarily based on speculators, but instead the home purchasers that believe someone will always be willing to pay more for their house.
The rising expectations of housing economics are closely associated with the adult population. If the adult population is growing then housing prices naturally have a tendency to rise. When it slows down, home prices follow suit by falling drastically no different than the Dow Theory that expounds the virtues of excess and repentance.
However, our most persistent dilemma is the supply development of the housing market. When excess housing production occurs in the boom-phase cycle, large developers should be making excess profit as the cycle continues to boom. This excess demand also drives up land values and enriches landowners. Any type of correction in the housing market has a deleterious effect on developers that are forced with rising costs, and to a certain degree, a shortage of skilled labor attributed to higher wages eating up their profits.
The Toronto Real Estate Board is oddly optimistic that the Toronto condo and housing market will continue another red-hot year of solid double-digit gains. This may be attributed to a lack of inventory with the same conventional wisdom stating, “You can’t buy what’s not available.”
The logical analysis illustrates a different story. If supply is not available then what governs the psychological makeup of an individual not wanting to sell their house even with multiple offers on the table and the prospect of huge capital gains? Perhaps the crucial risk of these sellers is based on overpaying an unprecedented level that accompanies higher debt levels.
The tremendous rise in house prices over the last decade is a national and global phenomenon. The housing boom has its origins after the great recession in 2008 with the increase of credit supply driven by looser lending constraints. Not only has this happened in the mortgage market, it has also spread to the equity market. If the equity market allows an imaginary wand to sustain their earnings, then it’s based on liquidity to buy back shares to fuel the perceived notion that people are making huge profits.
It’s the degree of rising home prices, household debts, and the presumed stability of debt relative to house values that cater to the imaginary wealth and consumption of keeping up with the Joneses. The slack of collateral constraints at the peak of the lending cycle usually triggers a fall in house prices. The origins in determining a bust may be rooted in the monetary movements that influence the price fluctuations of assets. This in turn has a powerful influence that affects income, expenditure, and inflation.
Certainly the real aspects of a boom-and-bust cycle will remain with nominal wage growth. Since the recovery began officially in mid-2009, we have seen low-and-flat wages consecutively for years. The weak labor market has put downward pressure on wages even with decreasing unemployment rates. If unemployment decreased then the real argument may highlight the real elusory market that is dominated by part-timers that have multiple low-paying jobs.
What is pervasive in the economic expansion and contraction of economic activity during the boom-and-bust phase is that the political economy does provide a bias towards higher spending and debt ratios. Unfortunately, credit growth with large increases in asset prices fuels the probability that financial instability will increase and fluctuate closely with boom-and-bust cycles.
Indeed, the monetary policy response to credit and asset-market increases has increased the likelihood of excess demand distorting economic decisions that give policymakers a streamed semblance of disorder in maintaining asset stability. If a correlation exists between rising house prices and the equity market then a monetary action phase will enter the equation when the bubble is rising.
The political theory and/or political equations suggest uncertainty about asset bubbles with the argument going against monetary policy targeting these bubbles. It’s very difficult to determine the existence of bubbles and how big they can get. The even bigger danger is the subsequent distortion that allows bubbles to grow excessively rather than having monetary policy that seems set to clean up when it actually occurs.
What are some possible risks of these asset bubbles for our Canadian economy? Studies of similar asset bubbles in 17 countries over the past 140 years prove that most of these bubbles have drastically different characteristics. Some blow over, but the majority pose enormous costs for a given economy. What’s certain is the danger of credit booms evidenced by the fact that asset price bubbles under these credit booms exponentially increase financial risks that are followed by lengthier recessions and slower recoveries. The phenomenon of credit-financed housing price bubbles can not be overlooked.
I told my friend that the only option in life is fuelled by animal instinct and the survival of the fittest. I choose not to go into debt or leverage my assets in order to keep up with the Joneses. We finished the wine. Remember my friend, a shark circles their prey until it’s safe to attack.
I'd like to thank Michael Ambrozewicz for his contributions to this article.