To bubble or not to bubble?

Hubble bubble toil and trouble. You can’t swing a cat these days without overhearing yet another conversation about a housing bubble forming in Toronto. For anyone that has recently bought a house, the bubble threat is scary. People always like to commend you on a “smart” decision if the price of your house rises significantly so I guess that means you’re the village idiot if the prices drop. The unfortunate souls who buy during the height of the market become the signature cheesy scene in every popcorn comedy, the dumb guy berated by his friends for making out with that hot chick who is, duh, totally a MAN in drag. How couldn’t you tell, sucka?

So what to do? Buy now or wait until the theoretical bubble bursts? I heard all the bubble hype when I bought my first house in 2006 and in three years the value increased by 32%. Had I waited, I certainly wouldn’t have been able to afford the same house even if I had bought in the pit of the market in Winter/Spring 08-09. So are we approaching a bubble? Will all the haters who bought in the suburbs or chose to rent finally get their moment of victory?

Are gloomier days ahead? Photo of Jones Avenue by Rémi Carreiro

If I could actually say with certainty that we were or were not in a housing bubble, I would be doing much more important things than writing this blog…like plotting world domination or making billions on the stock market. Before we decide on our current bubble or non-bubble status, it is important to actually define what a housing bubble is.

Contrary to popular belief, a bubble is not just a rapid appreciation in prices. In our current market, prices are rising because of strong demand for housing due to low mortgage rates and limited inventory. This is not by definition a bubble, even if average home selling prices rise quickly like, uh, say 19% from $343,632 in January 2009 to $409,058 in January 2010. A housing bubble is a market where prices rise purely on speculation of future increases, where buyers pay significantly over asking in anticipation of a perceived future value that may or may not bear out. Housing prices increase rapidly until they reach unsustainable levels relative to incomes and the pace of the economy and then SPLAT, you’re waking up next to a dude.

The largest freestanding bubble care of England's SamSam the Bubbleman. Incredible! Photo by The Sun

Is that what we’re experiencing right now? Unfortunately we never seem to really know if we’re in a bubble until after it pops. Why did people get so high on real estate fumes and Alberto VO5 hairspray in the 80’s? Over a five year period from 1984 to 1989, houses appreciated by 167% and interest rates hovered at 11-14%. On average in Canadian real estate hot spots, it cost almost 75% of pre-tax income to service mortgage payments, property taxes and utilities on a standard two-storey home, whereas that number is now hovering around 58.4% for Torontonians. It seems totally obvious to us now that the hot mess of 1984-1989 was going to end in tears. But, like a bad relationship, when you’re in it, the whole situation is never quite that simple. That old bastard hindsight is always to blame.

I’m going to go out on a limb here and say that I don’t think we’re experiencing a bubble just yet. While prices have made a massive increase from a year ago, it can be argued that we’re making up ground lost during the financial crisis. In December 2009, prices were up just 2% over the previous high in August 2008. Certainly the current acceleration of the market feels unsustainable but things should slow down as affordability erodes and the interest rates rise. What happens over the next few months will really define whether or not we’re going to bubbleland. Now that we’re basically caught up to pre-recession housing prices, how fast will growth be over the spring market and will speculative buying become a problem? Only time will tell…

For more information on Toronto’s potential housing bubble check out:

Frantic housing market ready for calm, Globe and Mail

Housing market in bubble territory?, Toronto Star

Toronto housing market expected to cool next year, Toronto Star

Bank of Canada says sees no housing bubble yet, Reuters

Jordan Says:

March 17, 2010 at 4:50 pm

I think “bubble” vs. “no bubble” is a matter of semantics. Looking at fundamentals of average household income (flat) and employment levels (not high) in Toronto, plus the kind of homes that first-time buyers are purchasing, it’s hard to believe that housing isn’t way over-valued here.

thehousefly Says:

March 18, 2010 at 6:01 pm

Thanks for commenting Jordon. CIBC World Market economist Benjamin Tal said in Jan 2010 that Toronto homes are overvalued by 4 to 6% based on historical trends and demographics. I know my salary hasn’t changed too much over the past few years but housing prices have increased by as much as 30-40% since 2005 in some neighborhoods, especially formerly “undervalued” hoods like Leslieville. It is now virtually impossible to spend less than $500,000 on a starter home if you want to be in a prime neighborhood. We hear so much about the possible bubble and potential collapse of the market but I’m curious if and when this may happen…I feel like we’re going to keep going up before we go down.

Kyle Says:

April 9, 2010 at 9:55 am

In all the bubble talk going on in the media, i don’t hear much to substantiate the argument for falling house prices, other than how the ratio of house prices to median household incomes is higher than in the past. While that ratio is growing, i think it is a flawed conclusion to assume we are at a tipping point, where house prices will go down. Here are 3 reasons on why that ratio isn’t necessarily a good indicator:

1. By focusing only on median household incomes, you ignore other sources of wealth that people often use to purchase houses such as equity from the sale of another property, converting equity from a stock portfolio, inheritances, stock options & ESOP, selling businesses, etc. I suspect as you look through the 90’s, 00’s, 10’s the number of people in this camp has been rising.

2. This ratio also ignores changes in the distribution of incomes. The median household may be a good indicator in “any town” Ontario, where everyone in town earns between 20-90K, but i don’t think it’s necessarily a good indication of the 416 area code, where households earn anywhere from 0-10,000K. I think in Toronto real estate prices are mostly driven by the “right tail” of the income distribution, and over time that tail has become fatter, meaning more high-income outliers. It is often said the middle class is disappearing in Toronto, so does it still make sense to use the middle household as the benchmark?

3. By Definition, the median household income in Toronto takes into account all households in Toronto, including a large proportion of people who can’t afford to buy a home, who have retired and down-sized or people who simply don’t intend to buy a home ever. So regardless of whether their incomes grow a little or not at all, there isn’t going to be any impact on house prices. If you were to exclude these households from the population and recalculate the median, the median would be much higher and rising over time.

Looking just at the neighbourhoods profiled on this blog, prices have changed a lot over the years, but so too have the incomes of the residents. Hoods that where once occupied by single income immigrant families are now occupied by double income professionals. I’m sure one day when prices are even higher than they are today, i’ll be telling my kids’ kids, “This ain’t your grandfather’s Roncesvalles Village”.