Is the Era of Rising Real Estate Prices Over?

era-of-rising-real-estate-over When I first moved to Calgary to work in the oil and gas industry in early 2006, it was right around the top of the property boom, and affordable housing was next to impossible to find.  Not wanting to shell out half my salary for an apartment, and spending months to fill it up with furniture, I decided to go the room rental route.

Little did we know at the time, but towards the end of 2006, the market was slowly but surely moving from sellers’ to one that favoured buyers.  Ones in the know, i.e. people with family members that dabbled in real estate, already sold in late 2005 or early 2006. But the media and the rest of us general public have always been slow to catch on.  And you wouldn’t know, from the construction buzz around the city, to the countless “For Help” signs hanging haplessly outside shop windows, to stories of McDonald’s and Starbucks paying upward of $14 an hour plus benefits to attract and retain employees.

My second landlord, a sweet spinster in her 60s, believed in the power of real estate as much as she believed in the miracle that is modern medicine.  She credited her various real estate investments for her comfortable lifestyle, despite not having worked out of her home for more than decade.  Her piece of advice to any young-uns that cross her path, is the adage that we should all invest in real estate sooner rather than later.  I can’t blame her or others her generation  for their spectacular confidence in the strength of the housing market.  Their experience of ever-rising property prices facilitated that expectation.  It certainly looked good at the time, with housing prices that doubled within a few years.  Houses that were hardly 1,000 square feet would go for 400,000 to 500,000 dollars in certain parts of the city.  The gains were ludicrous.  And the whole town was drunk on the sudden discovery that, thanks to oil sands in their back yards, a lot of them were paper millionaires!

In early 2007, cracks were already apparent.  One of my bosses bought a yet-to-be-built house on a new lot on a fixed price, while trying to sell her existing dwelling.  Within the span of a couple of months between when her house was valued, and when it went on the market, the price had already dropped by 10,000.  That’s the problem with houses.  You have to live in one. So unless one can capitalize on the gains immediately, and move elsewhere, one only ends up upgrading to an even more over-valued house.  Luckily, the housing boom in Canada, even western Canada, still paled in comparison to what went on in California, the UK, and Spain.  Even the sharpest decline was contained within teen digits.  But for the people that bought into the perpetual rise of property value, is the current market decline a temporary setback, or something that will linger indefinitely?

Jon Carney at Clusterstock seems to favour the latter theory.  From a demographic perspective, this certainly makes sense.

1. Baby-boomers in the US and Europe more or less carried the property markets for the last few decades.  Their continuous demand for housing, whether they be condos, starter-homes, or suburban mansions, drove the market.  As this population ages and trade down, we might se an increase in demand of condos, retirement homes or assisted living complexes, but a drop in market demands for larger homes.

2. Those of us who belong to Gen X or Gen Ys are just not large enough of cohorts to fill the shoes.  There’s the issue of massive student debts, due to the boom and the increasing necessity of acquiring a college education.  Then there’s the shortage of Gen X to move into excess dwellings available on the market.  According to Carney, “only 44 million people were born into Generation X. There are currently 19 million empty homes in the US. That means that if Gen X pairs up through marriages, cohabitation or roommating, they can live in the empty homes without ever buying a new one.”

3. There is compelling evidence that once a bubble bursts, it hardly ever reflates.  The Tulip bubble never came back again, nor did the tech bubble.  So unless the property market can demonstrates and rationalizes rising valuation, it will not climb back to the mid-2000 level.  The public and the media will probably move on to some other new asset class.

4. Inflation or deflation, the property market doesn’t stand a chance.  Should inflation take place from the massive printing job various governments around the world participate in, it can potentially eat up gains made in real estate.  Should deflation becomes the reality, then according to Charles Hugh Smith, “debt grows ever more burdensome as money becomes more valuable and wages and income drop. As a result, assets dependent on debt ( that is, real estate) drop in value. In deflation, real estate become a “capital trap” which loses value as cash gains in value. As incomes plummet, so do rents, i.e. the income stream which real estate earns, further impairing its value.”

5. Low interest lending is gone.  Interest rates will climb higher again, particularly in the US.  The artificial low interest rates can only last as long as the rest of the world had the cash and desire to lend it.  And the spectacular failure that came out of the Democrats’ goodwill to support low-income home ownership will have people questioning the wisdom of policies that justified low interest rates, perhaps even interest deductibility on mortgages that fanned speculation and unaffordable mortgages.  As a side note, Canada does not allow interest deduction, yet home ownership is higher than in the US.  Just saying.

picture source: semideus

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  • Gaurav

    Hey Dana,

    Great points there. I think the lesson to be learned – as always, is don’t lever up! A house is meant for staying in – and the whole stigma attached to someone who rents is just ridiculous. Home ownership really got stuffed down everyone’s throat. And now the results have come to bear.

    I don’t say buying a house is wrong, mind you. Home ownership is a good thing, and I can’t argue otherwise. But what makes sense (atleast to me) is to buy a home when you can put a good amount down, finance only a small piece of it, and stay away from exotic option ARMS and other such shenanigans. And ultimately buy a home that is nice and comfortable, not a sprawling McMansion (the other lesson that I think just hasn’t been emphasized enough) that makes you live paycheck to paycheck.

    I will disagree with you though on a couple of things. Atleast in the states, you’re not factoring in the effects of immigration. It may have slowed down recently, but immigration will certainly provide the floor in demand. Will it be uniform though? Maybe not. Maybe the supply of homes in suburbia will remain elevated relative to urban homes.

    And the bubble will come back – as 2008 goes further into the rearview mirror, risk taking will return, and asset bubbles will reappear. Nothing fundamental has changed in policy, so all it needs once again is cheap rates and continued reliance on the dollar as a global currency.

  • Gaurav

    Hey Dana,

    Great points there. I think the lesson to be learned – as always, is don’t lever up! A house is meant for staying in – and the whole stigma attached to someone who rents is just ridiculous. Home ownership really got stuffed down everyone’s throat. And now the results have come to bear.

    I don’t say buying a house is wrong, mind you. Home ownership is a good thing, and I can’t argue otherwise. But what makes sense (atleast to me) is to buy a home when you can put a good amount down, finance only a small piece of it, and stay away from exotic option ARMS and other such shenanigans. And ultimately buy a home that is nice and comfortable, not a sprawling McMansion (the other lesson that I think just hasn’t been emphasized enough) that makes you live paycheck to paycheck.

    I will disagree with you though on a couple of things. Atleast in the states, you’re not factoring in the effects of immigration. It may have slowed down recently, but immigration will certainly provide the floor in demand. Will it be uniform though? Maybe not. Maybe the supply of homes in suburbia will remain elevated relative to urban homes.

    And the bubble will come back – as 2008 goes further into the rearview mirror, risk taking will return, and asset bubbles will reappear. Nothing fundamental has changed in policy, so all it needs once again is cheap rates and continued reliance on the dollar as a global currency.

  • http://investoralist.com Dana

    Gaurav,

    Thanks for the comment. I think similar to what we talked about last week with instilling self-esteem into my generation which subsequently turned a lot into affirmation-seeking narcissists, a similar case of good intentions turned sour happened here.

    I have actually thought of the issue of immigration in the US. In recent years, the flow has steadied considerably. Or should I say, the flow of legal immigrants that actually have the money to upgrade into home vacated by baby-boomers have leveled off, if dropped. The current fiasco enfolded precisely because the educated and potentially well-off immigrants that had money could not access the dwellings. Yet the legislation passed by the governments mainly resulted in the poor, many Latinos and blacks hooked on programs and loans they cannot afford.

    Here’s the article cited in the blog, scroll to mid to bottom of the page, to see difference between the Canadian and the American immigration programs.

  • http://investoralist.com Dana

    Gaurav,

    Thanks for the comment. I think similar to what we talked about last week with instilling self-esteem into my generation which subsequently turned a lot into affirmation-seeking narcissists, a similar case of good intentions turned sour happened here.

    I have actually thought of the issue of immigration in the US. In recent years, the flow has steadied considerably. Or should I say, the flow of legal immigrants that actually have the money to upgrade into home vacated by baby-boomers have leveled off, if dropped. The current fiasco enfolded precisely because the educated and potentially well-off immigrants that had money could not access the dwellings. Yet the legislation passed by the governments mainly resulted in the poor, many Latinos and blacks hooked on programs and loans they cannot afford.

    Here’s the article cited in the blog, scroll to mid to bottom of the page, to see difference between the Canadian and the American immigration programs.

  • http://bretfrohlich.com/ Bret

    Dana,

    As a native of California, I have seen the bust and boom cycle in housing three times in the past 30 years. And, I have no doubt that I will see it three or four more times in my lifetime.

    The bottom line with housing is that it is tied to income and more specifically affordability. So, whenever I see tract houses selling for over $500K, I know the crash is coming soon. No matter how low the interest rates go, young couples can't afford $500K houses, so the prices will have to come down. And, the longer the industry and Government meddle with it, the worse the correction will be.

    The biggest problem I see with real estate as a long term investment is that real wages aren't going up. Maybe the wages of CEOs and politicians are going up. But, wages for most working Americans really aren't. If that doesn't change, the prices for real estate and many other items will stagnate.

  • investoralist

    Bret,

    Indeed, the stagnation of wages for middle-America can partially explain how people desperately looked outside of real income increases to accumulate wealth. Thus the first tech bubble, and since then, the real estate housing speculation. And of course, add the debts that people had become increasingly reliant upon to fund their lifestyles, we are in this mess today.

    You say that you're expecting more housing cycles in California, really? I am skeptical as to whether people will return to housing as an outlet from speculative activities going forward.

    Thanks for stopping by, really great to have you here.

  • http://bretfrohlich.com/ Bret

    Dana,

    As a native of California, I have seen the bust and boom cycle in housing three times in the past 30 years. And, I have no doubt that I will see it three or four more times in my lifetime.

    The bottom line with housing is that it is tied to income and more specifically affordability. So, whenever I see tract houses selling for over $500K, I know the crash is coming soon. No matter how low the interest rates go, young couples can't afford $500K houses, so the prices will have to come down. And, the longer the industry and Government meddle with it, the worse the correction will be.

    The biggest problem I see with real estate as a long term investment is that real wages aren't going up. Maybe the wages of CEOs and politicians are going up. But, wages for most working Americans really aren't. If that doesn't change, the prices for real estate and many other items will stagnate.

  • investoralist

    Bret,

    Indeed, the stagnation of wages for middle-America can partially explain how people desperately looked outside of real income increases to accumulate wealth. Thus the first tech bubble, and since then, the real estate housing speculation. And of course, add the debts that people had become increasingly reliant upon to fund their lifestyles, we are in this mess today.

    You say that you're expecting more housing cycles in California, really? I am skeptical as to whether people will return to housing as an outlet from speculative activities going forward.

    Thanks for stopping by, really great to have you here.