Is there a real estate bubble when it comes to Canadian real estate? How about specific markets, such as Vancouver and Toronto?
There’s been quite a bit of news lately about real estate bubbles in Canadian real estate. Today, several news articles appeared about Vancouver’s housing bubble ‘risk’ being “unmatched on the planet” according to a Swiss bank. (Read the article here.)
By definition, a real estate bubble is when prices of real estate rise drastically as a result of demand, speculation and exuberance. Demand in real estate is undoubtedly high. Supply continues to be depleted in hot real estate markets such as Vancouver and Toronto. But is there speculation buying going on? How about home buyers purchasing due to sheer exuberance?
Demand (and supply) — the basics of price increases
There is no doubt that the ever increasing demand is fuelling the rapid price increases in real estate. It all comes down to basic economics of supply and demand. In the Toronto market, approximately one in three homes available for sale last August 2015 is not available in 2016. That’s a huge amount — a third of homes is not available for purchase on the open market. If demand continues to grow, while supply is being depleted at such a high rate, prices shoot up drastically, which is why we are seeing double digit price increases year-over-year.
Speculation fuelling the real estate bubble
Many commentators giving their insight about Vancouver and Toronto real estate say foreign buyers are snapping up properties and driving up home prices for Canadian residents who genuinely want to get into the market. This is affecting the first time home buyer crowd more than any, as entry level home prices have skyrocketed in recent years.
Articles such as this one tell how foreign buyers are expected to drive up Toronto home prices, after Vancouver introduced a 15% tax for foreign buyers.
What we really should consider outside of foreign ‘speculative’ buyers are domestic (Canadian) buyers who are buying on the speculation that home prices will keep going up. Afraid of losing out and missing their opportunity to buy a home, some first time buyers are jumping in and grabbing their piece of real estate before homes become out of their reach. This is speculative buying by definition. And it’s not just foreign buyers doing it.
Buyers voraciously buying real estate amidst a depleting supply of homes are driving prices up. Probably more so than foreign buyers. Has anyone ever questioned how many transactions are actually made by foreign buyers versus domestic buyers speculating that prices are going to be out of their reach if they don’t act now?
Exuberant real estate buying
Is this Vancouver shack worth $2.4 million dollars? Is that the definition of exuberant real estate buying these days? The answer to whether (or not) this real estate investment was the right choice depends on what the buyer expects to get out of it. Exuberant buying, to me, means buying for luxurious or opulent reasons. You own a house, why not have two? Or you’ve got a lot of money burning in your pocket, maybe it’s time to move to Rosedale?
There’s an interesting thing to note about the Toronto real estate market. Multiple offers and high ‘sold over asking’ prices are mostly seen in ‘average’ homes around the $800k to $1.4 million range. In Toronto, these homes aren’t exuberant. Homes in the $2 million and up range tend to sit on the market longer. Sure, there’s still a market for them. But not as big.
Is there a real estate bubble?
Many people wonder how this will play out. Will government policies make homes more affordable? Does reducing and discouraging foreign real estate buyers slow down the rapid increases in home prices? How about the upcoming mortgage rule changes? Will they affect home prices as a result of higher insurance premiums or interest rate increases?
The real question is whether or not it matters, and how it will affect you.
If prices are due for a correction, and you’re buying a home at the peak, as long as you are able to afford your mortgage payments and ride out the price movement, you should be okay. Don’t buy a home just to jump on the bandwagon because you think the average price of a home will be a gajillion dollars in three years. Be smart and conservative. If you can’t afford mortgage payments, rent while deciding what to do. Save up for a bigger downpayment, or at least make sure you know you can afford your mortgage payments if interest rates go up. (Which is something we don’t have control over.)
If supply and demand dictate what will happen in the market, the logic of economics tells us one thing. Limited supply with high demand will drive prices up. But outside factors such as government policy changes or interest rate increases will affect prices. When the government taxed foreign buyers in Vancouver, sales (and prices) started declining. If mortgage rates increase, affordability is affected and prices will drop.
What should you do?
No matter what’s happening in the real estate market, you have full control over what happens after you buy. Prices continue to rise? That’s great, you’ve got an asset worth more than when you bought it. Prices drop? As long as you’re not selling at a loss, and as long as you’re making your mortgage payments, you’ll be fine.
Real estate appreciation is linked to inflation. Over the years, the average price of real estate has consistently gone up. Even after real estate market crashes such as in the late 80’s to early 90’s, you’d still be ahead if you held onto your property.
So go ahead — buy a home if your lifestyle dictates it — as long as you know the implications that will affect you. Rent if you’re not that confident, until you figure out what you want to do.
Just make sure you can afford whatever choice you make.