Is the real estate market due for correction?

There is a lot of speculation and fear about a bubble in the market. While there are concerns about a bubble in some markets in the US and possibly Vancouver, is there cause for concern in the rest of Canada?

Regular market

Similar to the stock market, the real estate market also has cycles. First, some months of the annual cycle are slower than others – winter is a slower time, summer is usually a more active time for buyers and sellers. Second, demand and supply, interest rates sometimes make adjustments in the marketplace.

It is important to note that a “bubble” is not part of a normal market cycle. It is an artificial increase in demand – not based on fundamentals, often based on speculation, misinformation and greed.

What is a bubble?

In the dot-com era, tech stocks traded at extremely high price-earnings ratios, which were not supported by market fundamentals—that is, stock prices had a weak relationship with company profitability. Instead, it was based on anticipation. People expected dot-com companies to leave the future and were willing to finance them, even though these companies had no income or collateral to back the equity loans they were taking. While some dot com companies like Amazon and Google made it big, most failed. The tech bubble burst for one simple reason: all these companies exiting at the same time created an even higher supply of demand for their products. Buying and trading was done only in future cash dreams. That is the basis of all, if not all, “bubbles”.

What about the real estate bubble?

Real estate, on the other hand, is a basic need – everyone needs accommodation. It has limited supply – land is scarce because no one owns it. In addition, artificial barriers created by the government (greenbelts, conservation land, agricultural land) will further overcrowd land and increase the demand for other areas for development purposes.

Due to population growth due to immigration, demand for real estate around business centers (such as Toronto, Vancouver, Edmonton, Montreal) has increased. Since land is very expensive in these areas, developers can solve the over-sizing problem by building in these areas (high-end condos). And because most people prefer single-family homes and developers are expected to build less in these areas, such homes will see price increases.

To summarize so far, bubbles are fueled by artificial demand, not justified by the fundamentals (normal supply and demand) – people start buying and selling on speculative speculation with no current market reason for high demand. Real estate has an ever-increasing demand and limited supply that is not expected to change anytime soon.

Is it all for real estate?

This means that housing prices will not decrease, not at all. As with the normal real estate cycle, prices occasionally adjust to reflect current market supply and demand conditions.

Let’s first look at the destruction of the 90s to see if the same fundamentals can be seen in the marketplace today.

Crash of the 90s

In the 90’s over 30% of people buying in the Toronto area were investors, as interest rates continued to rise, these investors could not afford the financing costs that caused them to either sell or be foreclosed on by banks, resulting in overdrafts. supply of property in the market (especially condos); The oversupply has caused the price to drop. The decline in prices caused investors who had recently taken losses out of the market (further reducing demand). And end buyers noticed the downward trend and decided to wait a little longer in the hope that property values ​​would drop further and properties would be negotiable. This waiting game took years.

Only 19% of condos in Toronto last year were rentals (according to CMHC’s Housing Market Outlook for the second half of 2005), and vacancy rates are falling. That’s because most people buy for themselves, not for speculation. So even if the rental market slows and vacancy rates begin to rise, the real estate market is unlikely to be as flooded as it was in the early 90s.

Proportionality

Interest rates were the main reason for the adjustment in the early 90s. In May of 1990, interest rates were a whopping 14.21% (according to CMHC), paying $11.89 for every thousand dollars in mortgage loans. This $400,000 mortgage costs $4,755.97 per month. Currently, you can get a 5-year loan for about 5.25%, or $5.96 per thousand dollars in your mortgage. That means a $400,000 loan today would cost you $2,383.67 a month. This means that the effective cost of home ownership is half of what it was in 1990, but the average price is now 5%-10% higher than in 1989.

Summary

The adjustment in the early 1990s was a response to excessive speculation and excessively high interest rates. In the late 1990s and into the present, housing markets were valued in the 1990s and consumer attitudes made another adjustment to accept that homes were affordable again. Now that the price is starting to reach a point where it’s selling at a reasonable price, we’ll see prices moderate with low price increases and occasional peaks and valleys that represent a normal market.

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