How to know if you in real estate bubble?

Factual Questions
21

Each of the items on Nava’s list also applied in the Irish bubble. Another feature of the Irish case was housing being built in the middle of nowhere, far from any employment, amenities or services. Those are now called “ghost estates”.
A thought about the Irish bubble. Many experts correctly predicted that the bubble would burst, and when it eventually did, they could say “I told you so”.

If any of those experts had sold their own house in early 2008 and rented for 2 years before buying an equivalent house, they could have pocketed say half a million profit.

Now, they may say “I’m not interested in doing that; too disruptive; my home is not an investment”, etc. But that’s a lot of money to leave on the table if they really, truly believed in what they were telling us.

22

Another issue with Toronto - if you follow the chat rooms for landlords, the landlord-tenant rules for Ontario are extremely biased in favour of the tenant. A slimeball who knows the system and is not worried about their reputation can manage to live for months in a rental unit without paying rent and stalling the arbitration and eviction process, making up phony complaints, etc.; these types are also a waste of time for the landlord to chase for back rent when they are finally evicted.

As a result - an inevitability under the laws of economics - nobody builds much rental housing, and most new apartment construction is condominium. With a severe shortage of rental housing, rent is higher, and with low interest rates people are motivated to buy a house as soon as they can.

There were elements of the bubble in the Toronto market - buying for speculation, etc. But there was also the underlying demand for real housing.

Additionally Canadian law does not allow you to deduct mortgage interest payments on the family home, so there is more incentive to pay off a mortgage and much less incentive to refinance to the current market value. This is one of the biggest destroyers of the American housing market - even a lot of homes owned for a long time were refinanced to the bubble-induced unrealistic evaluations. In Canada, homes owned for many years tend to be close to paid off.

Also, the ARMs were a factor in the US bubble; people were offered “expolding ARMS” where their adjustable-rate mortgage was deceptively affordable for a year or two, then suddeny the interest rate shot up. Such tricks were pretty much unheard of in Canadian banks, so much of the house debt here was at least in some way affordable for the buyers. When purchase costs are by definition unaffordable - a game of hot potato, gotta sell in 2 years - then that’s a recipe for a disaster in 2 years.

Most Canadian mortgages needed to be insured, meaning the buyer had to meet income criteria set by the insurance company (usually CMHC) who had to worry about default; in the USA, the buyer simply had to sign and the bank who should have worried about the debt’s reliability instead flipped it to others who had no way to find out it was a disasterous loan.

23

Indeed, Robert Shiller had been warning about the U.S. housing bubble since at least 2005.

24

If the median multiple (the value of homes vs the household incomes, so household income of 50k and a home worth 150k is a median multiple of 3) gets too high that could signify a bubble. My brother lived in San Diego and he said it was something like 5-8 when he lived there, it should be 2-3.

The only way people can afford homes on a high median multiple is if credit has gotten really lax. And if the median multiple is too high, and there are a lot of adjustable mortgages, that means there will be tons of foreclosures which will drive prices down since supply will increase.

25

When they start calling you in your office, and tell you about fantastic ways to re-finance your down payment and balance, and tell you you’ll be way ahead of the rest of the market and you’re getting a bargain.

26

Find a chart of the Case-Shiller index values for real estate:

This is the price of real estate adjusted for inflation. Here’s the Wikipedia entry on the Case-Shiller index:

Look at the chart at the first link above. From 1987 to 1997 the values are relatively stable. In 1997 the values start rising faster. In 2005 they take off like crazy. Real estate values can never legitimately rise this fast. This must be a bubble. In fact, it was. In the second link above there is a chart of Case-Shiller index values over a longer period. It should be even clearer there that there was a bubble that popped in 2007.

In general, this is true of the market in anything. Huge increases are not sustainable. The Dow-Jones index has increased an average of 5.1% a year since it began in 1896. You can tell when a bubble is going on in stock prices based on the increase. The Dow-Jones index increase by 495% over nine years in the 1920’s. Not surprisingly, this was a bubble, and the market fell by a huge amount.

In general, don’t buy anything when the price of it is increasing fast. You should never be buying anything because someone tells you that the price is going up fast and you have to get into the market now. Buy real estate when you need it, and if you can put off buying it when the market is rising fast, do so. This is really pretty basic advice - buy low and sell high.

27

Should note that Japan preceded the US bubble, and the US seemed to learn very little from it. That is a link to a December 2005 article in the NY Times about the aftermath of the Japanese housing bubble. The US was about two years away from the peak of their bubble, but most pundits refused to believe that it was occurring. Earlier that year, I told a colleague that I felt that housing would not be more expensive in five years so I did not want to buy anything. I could have said that it wouldn’t be more expensive in ten years and probably been correct.

28

I bought just before the start of the bubble. I own a 2-family house at the end of a row of 3 identical houses (known as the “Three Sisters” when they were built in the 20’s). They’re all in roughly the same condition (one might have a better roof while another had been converted from oil to gas heat, and so on).

I paid $X for mine. 3 weeks later, the identical one next door to me sold for $X + $110,000, a figure that was arrived at by several potential buyers getting into a bidding war with the winner ending up paying well over the asking price.

Today (well, a little over a month ago), even after the bubble collapse, I was contacted with an unsolicited offer for $325,000 over what I paid for this property.

29

Here in Toronto, some dispassionate observers (including the experts) have been predicting that Toronto’s market is in a bubble every year since around 2002 or so.

http://realtytimes.com/rtpages/20020314_toronto.htm

Many of the bubble-spotting factors were observed, such as absurd feeding-frenzy style auctions, and intensive construction everywhere.

I remember this debate keenly, since many very clever people were advising me at the time not to buy a house, but to wait until the bubble burst and pick one up more cheaply. Fortunately I disregarded this advice.

Over the last year or so, bubble warnings have gotten ever more alarming. Last year,the experts were absolutely certain that the bubble was about to pop, and more or less laughing with scorn that the rubes weren’t alarmed.

http://www2.macleans.ca/2012/02/28/youre-about-to-get-burned/

No doubt it will eventually. Maclean’s proclaimed themselves right - the bubble has burst in January:

http://www2.macleans.ca/2013/01/09/crash-and-burn/

Perhaps a bit prematurely.

But people are still waiting. This year, people waiting to buy are starting to complain - hey experts, where is that bubble popping you guys promised us?

I dunno what the average person is supposed to make of this.

30

The thing that made he US bubble so much more volatile:

Many US homeowners would typically remortgage to the max (and use that mney for toys); this since mortgage interest is deductible. Since that does not apply in Canada, even if prices are being driven up the vast majority of houses are nowhere close to fully mortgages, and are being paid down more every day. As a result, people whose circumstances FORCE them to sell in the USA could not afford their mortgages; whereas someone in Canada, laid off, could likely survive longer since payments and principle were in general much lower if the home was not recently bought. This means a lot less panic desperation sales.

Similarly, the banks were insured by CMHC - no loss if they repossessed. CMHC then owned the house and their mandate was to sell at “fair market value”. During the last serious downtun in 1980, CMHC owned a massive number of homes in some communities. However, their houses, while a bargian, were not seriously undercutting the market. So the bubble does not burst as heavily.

I think what we are seeing is situation where the market has been adjusting to the new economic reality; in the modern western world, to live an adequate lifestyle, you need two incomes. There are a lot fewer stay-at-home moms. As a result, a decently employed couple (he’s an engineer, she’s a teacher) would have an income well above $100K. (Average income as per Unemployment Insurance coverage is about $42,000 this year). When average income pushes $100,000 a home 3 times that is $300,000 - and of course, in a tight and busy market like Toronto, even higher.

I also have a theory, based on the experience of myself and those around me - we bought our Canadian homes back when they were “cheap” decades ago. Then we sold and moved recently, to recoup th value in these homes. In my case, after 25 years I made over $170,000 plus mortgage was paid off. Add in savings not in retirement fund, and I have a half-million dollar, newly built, very nice home with a mortgage of about $170,000. I may be one of those bidding up prices - so were many of my neighbours (except for the doctors and business owners). My point is that this is a limited pool. The number of people wanting to “move up” and with the booster funds from house appreciation is limited. One that phase passes, who’s left?

Basically, the problem with Toronto is land is so tight (and nobody’s helping with commute distances) that it may end up like european cities, where the “new house” the starter family can afford is a condo apartment.

31

OP,

My experience is entirely in commercial real estate but we had a similar boom and bust cycle. I guess the basic answer is that a bubble occurs when you have a rapid appreciation in prices without a strong fundamental basis.

An economist that I spoke with a lot used to say that the real price if a home should be = Cost of Land + Cost to Build + Developer Profit. For the sake of this, we will say that is 15%. Cost of land is pretty tough to define since it doesn’t trade often and no two parcels are identical. But we can say that a piece of developable land in Honolulu is worth more than a parcel in Shreveport. And home prices should be appropriately higher in Honolulu.

In a lot of the areas where the bust was so pronounced, Phoenix: Vegas, Inland Empire, Florida, you actually had decent population growth that were driving prices higher. But getting into 2006 and 2007, you had massive oversupply but prices being bid ever higher. At some point, there was a disconnect between prices going up because of real population growth and prices going up because homebuilders and sellers were pricing higher and buyers were stupid enough to pay the tab. (Low interest rates, perceived wealth, sense of urgency all fed that). The prices of homes were so grossly in excess of that measure I discussed earlier that homebuilders were compelled to keep building.

Now if you look at areas that are densely populated, Manhattan, San Francisco, you can still have a run up in prices, but you probably got less of a bust in the last cycle. They have relatively low population growth. But, It’s really, really hard to overbuild there. People try. In the dotcom years, prices in SF certainly outpaced their “real” value and there was a correction after dotcom millionaires found out that their shares were worthless. But aside from an occasional correction, you just can’t overbuild these markets to the levels that Phoenix and Las Vegas had. And those markets usually have some fundamentals behind them. When Wall Street bonuses are up, condo prices are up. Tech hiring pushes up prices in SF. Even after corrections, you may still be ahead or just a bit below what you paid.

So I guess I said all that to say this. You have to determine why prices are going up in a given market and where they are relative to some of the measures like land value, construction costs. If things look out of hand, they very well could be. But if you have a densely populated city, with real supply constraints and no looming industry meltdown like a dotcom bust or the oil bust in Alberta in the 80’s, then the price growth may be real. Maybe you can buy on the dips, maybe not. Just be smart about what you buy.

Sorry if this sounds incoherent, I’m writing this from the lounge in Honolulu and its been a long day.

32

I have to say I know one expert in Ireland who did precisely what you suggest. Except that he hasn’t bought his replacement house yet. He’s still renting.

33

There’s probably quite a while left to go yet. House prices have halved since 2007 and don’t look to be starting to shoot up again anytime soon.