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11 Feb

Bubble. What Bubble?


Posted by: Kimberly Walker

Feb. 10, 2010

Since last October, home resale numbers have almost doubled, up 41.5 per cent and setting new records in Toronto, Ottawa and Montreal, all according to figures from the Canadian Real Estate Association (CREA). It’s stats like these that prompted economists from Scotia Capital, Derek Holt and Karen Cordes, to publish a report aptly titled, “Is there a Canadian Housing Bubble?”

And considering the data, it’s not an unwarranted question. Holt and Cordes plainly put forth that “Canadian house prices are rich no matter how one looks at it, but they are likely to become richer yet before material risks emerge later next year and beyond.”

They even answer their title’s question with the retort, “probably,” but elaborate that the combination of low rates, mortgage innovation and shortage of supply will keep it at bay for awhile.

In the Globe and Mail, Holt and Cordes said that “with prices up 20 per cent over year-ago levels and at all-time highs by virtually every measure, this is becoming an over-valued asset class in our opinion.”

As for the argument that increased affordability is driving the market, Scotia Capital claims that using affordability as a valuation measure is not a fair valuation at all, as “affordability is often just an interest rate at play.”

In other words, they believe that a housing bubble is well on its way.

Choose your words wisely
The word bubble, especially when it’s used in conjunction with the phrase real estate, has a fair amount of weight behind and shouldn’t be used lightly. When CMP contacted some of last year’s top 50 brokers, for instance, they tended to agree the so-called bubble was as imaginary as the mortgage monster under your bed, and what the industry is experiencing is simply a sharp rebound. For them, it’s the difference between performing the pole vault and landing on your back with the crash mat, or without it. In other words, the market will have its ups and downs, but this time when it does go down it won’t hurt too terribly.

Peter Kinch, of the Peter Kinch Mortgage Team in Vancouver, believes that everyone is confusing leftover pent-up demand from 2007 to 2009 and the current low interest rates as a possible bubble.
He defines the term bubble as “an overexuberance of activity not founded on any core fundamentals, resulting in irrational buying behaviour of the public.”

In a true bubble it’s not enough that consumers can afford a house, but they have to chase after it like a stock that they know is over-inflated, hoping to make a quick return on it. Kinch calls this chase “the greater fool theory,” in which the consumer hopes to buy an over-inflated priced house in hopes of flipping it in the short term to a greater fool.

Not only that, but for there to be a housing bubble Kinch finds it imperative that interest rates and unemployment rates increase sharply, resulting in a significant increase in defaults and fear. In turn, many houses need to be unloaded on to the market at once.

“I do believe there is fear-mongering that goes on in the media where people say, ‘Oh, geez. I saw in the Globe and Mail today that interest rates are going to go up and it’s going to cause a crash in the housing market.’ Well yeah, theoretically,” said Kinch.

However, he claims that the Bank of Canada would not drastically increase the interest rates at any given point. This is because of how closely tied the real estate market is to the economy, and more specifically, the Canadian dollar. The lower interest rates we see now are meant to stimulate the economy, and Kinch believes that the Bank of Canada would not arbitrarily destroy such economic stimulus by raising the rates too high or too quickly.

Dwight Trafford, of Mountain Mortgage in Orangeville, Ont., believes that people are currently being very reactionary to the market.

“There is some perception that there are still deals, and some perception that rates will rise,” he said. “With that, people are jumping in and trying to take advantage of both situations.”

He also blames the media for creating something new to report. “Saying that there isn’t [a bubble], that’s not news,” he said, adding that cases of multiple offers also tend to lead people to believe that there is a bubble.