Saturday, April 18, 2009

Hindsight is 20/20

Over the last while I've been reading through the archives of the Edmonton Real Estate Blog, just to get a feel for the zeitgeist of boom here in Edmonton.

Hindsight being 20/20, it's quite interesting to read through it. I've currently read up to early 2007, so as a reader today we are privy to the added context that the bubble is about to burst soon.

The old adage that those in a bubble don't seem able to recognize it until it burst also rings true... and while it would be easy to sit back and take pot-shots, it's worth noting that two or three times during 2006 Sheldon as much as said that the market was on the cusp of a bubble and if things didn't slow down, and we'd be repeating the bust in the early 80's. He seemed to recognize it, but didn't really want to acknowledge it's arrival.

One post that did strike me as quite interesting, and worth examining is this one by his cohort in February 2007, 5 Signs of a Housing Bubble in Edmonton.

So, I'll give Ms. MacLennan's take, then my rebuttal.
A housing bubble is characterized by rapid increases in the valuations of real property such as housing until unsustainable levels are reached relative to incomes, price-to-rent ratios, and other economic indicators of affordability. This in turn is followed by decreases in home prices that can result in many owners holding negative equity, a mortgage debt higher than the value of the property.

So lets compare this information to Edmonton. Here is our real estate bubble checklist:

1. Rapid price increases...check.
I'm with you so far
2. Prices reach unsustainable levels relative to incomes...nope
Um, actually they did... in a big way in fact. Incomes and prices tie into affordability, which comes up again in point 4. But to make the point quickly, incomes may have rose 30% by some measures, but home prices doubled over the same period. I believe this graph summed it up nicely.
3. Price to rent ratios...nope - prices have increased faster than rents, however, the vacancy rate is at an all time low and rents are increasing quickly.
She seems to kind of qualify her answer, admitting they actually had decoupled, but that it was just a matter of time before rents eventually caught up. It could be argued that that would be a reasonable assumption at the time... but, we know now that assumption turned out to be incorrect, rents never caught up, and now both they and prices are dropping.
4. Prices are too high to be affordable...nope - see this article on how real estate is now more affordable than it was in the 80's. Mortgages are still easy to get, and although you can't buy the big house on the hill in Edmonton for the bargain basement prices of a few years ago, housing in all price ranges is still selling and selling quickly.
There is one big flaw with citing that article. It was comparing prices from exactly 25 years earlier... as exactly 25 years earlier, we just so happened to be at the height of the last bubble (graph). I'd imagine those in the real estate field at the time could relate that the aftermath of that bubble popping wasn't pretty.

Bottom line, prices got out of line with affordability then, and were again at the time of that post being written. That things are selling well during a boom really shouldn't be a surprise, and certainly in no way dispels the presence of a bubble.
5. Homeowners with negative home equity...big nope - this is what is currently facing homeowners in the US. The majority of first time buyers took out "exotic" mortgages (aka 0% down, 40 year amortizations etc.) giving them no equity in their homes, and when prices did fall a few percentage points they ended up with negative equity. These mortgages do exist in Canada, but only make up a small percentage of the mortgages being taken out these days. The other reason so many Americans have negative equity was a huge surge in re-financing, which spurred consumer spending boosting the economy further which all fell apart when housing prices slipped only a few points. Again, the picture here in Canada is much rosier.
Incorrect, we just hadn't got to that stage yet. As we've seen, negative equity was possible (as some people already find themselves in that situation), and that was the original condition.

If this had been posted a year earlier, the contention about 'exotic' mortgages would have largely been true... In February 2006 you needed at least 5% down and could amortize no longer then 25 years. But by February 2007, we had all kinds of 'exotic' mortgages, and 60% of first time buyers were taking out 40 year amortizations. I imagine a large chunk of those were the 0% down variety (frankly, I'd consider any 40yr mortgage as 'exotic', but I digress).

In the US only about 22% of mortgages were "subprime" where as here in Canada 7% were "subprime"... but those were not including 0/40's. As I explored in this entry, our non-prime lending was just as bad here in Canada, as it was in the US. As prices creep further and further down, we're increasingly finding out we are just as susceptible here North of the 49th.

Now, I don't want to come across as picking on her, as two years later we are obviously privy to a lot of information she was not, and many of her assumptions were widely held at the time... it was appealing, who doesn't like to think they're on a gravy train with biscuit wheels?!

What I wanted to do was to take a definition of a "bubble" from during the boom as well as the contemporary thought of the time... then re-examine it from our current context and what we know now... and it now appears that it's quite arguable that we in fact filled all five of the criteria for a 'bubble'.

I'm sure in two years some of the thing I have written here will be laughable... heck, there is stuff I wrote three months ago that I now cringe about and know they're going to be wrong. Alas, that's the beauty of blogging, once you hit publish it's out there for better or for worse, typos and all.