Stages of a Real Estate Bubble

A few days ago I discussed the quantitative data showing that Vancouver and Toronto are in real estate bubbles.

Today I’m going to look at some of the psychological factors. After all, a bubble is defined by speculation and defiance of logic which is psychological.

The chart below nicely sums up the stages of a bubble:

stages_bubbleToronto – Delusion and a New Paradigm

Here’s a chart showing the average house price adjusted for inflation in Toronto (source) :

gta-avg-price-chart

As we can see, the prices in Toronto have gone parabolic in the last few years. Is this an indication of delusion and a new paradigm? The chart certainly seems to say so. The general thinking around Toronto seems to be that prices can only go up and will never fall: “Prices can never fall here”; “prices will only go up”; “there’s too much immigration for prices to fall”; “there’s too much foreign money for prices to fall”; “Toronto is becoming like New York and London” and so on. But people ignore the fundamentals. They ignore that fact that people aren’t making more money. Rather the focus is just on prices going up. The price increases carry the day.

This is the stage where everyone jumps in, all logic is defied, bully bids are common, everything goes over asking, and speculation is rampant. People take on maximum leverage to get in. It’s now or never. Sound familiar Toronto residents?

Relaxed credit policies allow the bubble to continue longer than most rational people would expect. The contagion usually spreads from the city center to the suburbs with price appreciation in the suburbs lagging the city. Fundamentals no longer support prices. But what happens when all of this ends? Vancouver.

Vancouver – Denial and Bull Trap

Here’s a chart showing the average house price (broken down by segment) in the Greater Vancouver Area (source):

vancouver-real-estate-year-price-chart-from-1977-to-december-2016-768x627

The Greater Vancouver area seems to be caught in the denial and bull trap phases. This also seems to be thinking throughout the region. Vested interests are reassuring everyone that this is a temporary setback and everything will return back to normal in the Spring. But Vancouver is already seeing properties list for well under July 2016 assessments and list for well under previous sales prices. I say “list” and not “sell” because nothing is selling. Sales have plummeted. The takers have disappeared – likely expecting prices to drop. If buyers don’t show up in the spring, you could see more sellers try to unload their homes. Just as panic buying happened on the way up, there will be panic selling on the way down. Sellers undercutting each other just to get out.

Some think there are lots of buyers waiting on the sideline to jump in. Yes, some people may jump in (the bull trap), but by this time the gig is already up. The music has stopped. Credit is tighter. The banks are unforgiving. Speculators want to bail. Fear is a powerful emotion and generally spreads fast. People think something that was a great investment is no longer the case.

The decline won’t play out overnight but will likely take time. As noted in the early 1990s declines in Toronto and Vancouver, they were long and drawn out – the same scenario may play out again. The decline will eventually reach the suburbs of Vancouver and Victoria.

When housing was going ballistic in spring/summer of 2016 in Vancouver, everyone was saying “real estate prices will never fall in Vancouver”. However, the narrative is slowly starting to change. People forgot that real estate is an asset class like stocks and bonds and goes up and down. People are slowly starting to accept the fact that prices can fall.

Some people say, “if prices decline by 30%, we’re back at where we were in 2014 and 2015.” Yes, that may be true. But think of all the people who bought during the run up with 20% or less down. At mortgage renewal time, these people may be underwater – owing the bank. This may make things really messy.

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