Statistical aberration or ‘the new normal’?

Hello all

Do we all understand supply and demand?  You know, you take something that is in demand, be it a good or a service, and you compare the supply of that good or service to the demand for it.  Very basic economics tell us that if demand outpaces supply, you get price increases.  If supply outpaces demand, you get price decreases.

Think about an auction.  If only one person wants one of those cheesy collectible spoon, that person will get it for a good deal.  But if 10 people want that same spoon, the price rises substantially.  Now if we increase the supply of spoons to 100 and keep the buyers at a stable 10, the price once again plummets.  It’s pretty simple.

So let me give you a little scenario and you tell me what would be logical.  We’ll pretend for a moment that we’re talking about collectible spoons.

Supply in September 2009:  Approx. 5700

Demand in September 2009:  Approx. 1400

Price in September 2009:  Approx. $900,000…..These spoons are really awesome

Supply in September 2010:  Approx. 6500 (+12%)

Demand in September 2010: Approx. 900 (-40%)

So, increased supply, massively decreased demand should mean a drop in average price, all things equal.  Right?  Wrong!  Not in this messed-up auction.

Price in September 2010:  Approximately $1,000,000

You may have figured out that our ‘collectible spoons’ actually represent the typical detached Vancouver home.  In one of the glaring examples of a statistical anomaly, Vancouver saw home prices rose not only year-over-year in September, but also month-over-month.  September marked the third time ever that the prices of detached homes in Vancouver topped the million mark.

So should I throw out my predictions of a 50% peak-to-trough reduction in the Vancouver detached home market?  Not at all.

Let’s try to make sense of these crazy numbers.  I have a few ideas about what could be driving this anomaly.  Let me assure you that none of these ideas have anything to do with sustained house price increases in Vancouver (or any large centre for that matter).  You can have prices rise in the face of massively falling demand for a while, but not on a sustained basis.  This is the most elementary rule in economics.

So let’s make some sense of this.  One of the interesting things that happens when you look at the average of a smaller sample size is that the average is more easily moved higher by outliers.  Suppose ten monster $20 million mansions sold in a month where 1000 houses sold in total.  This would have the effect of pulling average house prices higher, but not nearly as much as if only 100 houses had sold.  Could this be the explanation?  Possibly, but I think there is a better explanation.

Let me refer to two pieces of anecdotal evidence for a moment:

Exhibit 1:  A letter from Shayne Fedosenko to Vancouver Island MP Keith Martin.

Thank you for taking my call regarding the huge concerns and hardships in the new mortgage qualifications regarding suite income and people having to qualify.

This is the way that it used to be: you could take the suite income, say it was $1200/month and they would add it to your mortgage qualifications as a $200,000-$250,000 increase in your qualification amount, now what they do is take the amount of the rent: $1200 /month, multiply it by the 12 months in a year and add it to your income, making only an extra $ 40,000+ to your qualification amount.

This is why the market has completely softened. The market is completely dead. Brand new houses in Sooke, down to $299,900 from $399,900, no calls. The market has dried up all due to financing. I talked to 7-10 mortgage brokers and many agents while I was at the Victoria Real Estate Board golf tournament and everyone is scared. Hundreds of foreclosures coming, about 75% of the home owners could not qualify to buy their own houses (especially with suite).

So what happens when their term of mortgage is up and the banks need them to re qualify? They are doomed. Please look into it. Last month there were 300 home sales on the Lower Vancouver Island with 4700+ listings. One of the worst ratios ever. End of June is supposed to be the closing day of the year. Every Realtor has a few nightmare bank stories right now. Keith, this will put us into a huge recession.

Shayne Fedosenko
Pemberton Holmes Ltd.

Interesting.  Translation: CMHC rule changes have killed affordability and therefore demand at the entry level.  I can buy this.

And by the way, Shayne was remarkably prescient in his warning:

Where are those rich Asians who will supposedly support real estate values in the greater Vancouver area?

Exhibit 2:  A blog entry from Victoria mortgage specialist, Frank Simon.  Now I know we’re talking about Vancouver home prices, but the same fundamental drivers of supply and demand apply equally when we’re talking about two locations separated by 40 km of water.

To the entry:

“Yup, the last number of years have been great for equity accumulation.  But something happened on July 1 of 2010.  The demand for housing stopped.  The home equity bubble burst.  Interest rates were at their lowest in history, yet mortgages couldn’t be given away.

The dreaded HST happened in Canada’s two largest housing markets, both at the same time.  After years of a booming housing market, it all came to and end with a thud.  ALL BECAUSE ANYBODY THAT EVEN REMOTELY HAD PLANS TO BUY A HOUSE HAD NOW DONE SO.  There’s no demand for housing left.”

Now anecdotes don’t prove anything, but in the absence of hard facts to support or refute a claim, they at least offer an element of insight.  So what do we make of these two anecdotes, and how do they relate to the statistical anomaly that was the September real estate market in Vancouver?

I’ll give you my theory of what is going on.  Demand from first-time buyers is down.  Way down.  Remember that it is not uncommon for a housing sale to actually close 90 days later.  In other words, the deal is done and recorded as a sale, but the money and the house don’t change hands for several months. Now many people who sell their home will immediately go out and put in an offer on their next home, aligning the closing dates.  But not everyone does so immediately, meaning there is a residual effect from earlier home sales some months into the future.

If you remove a substantial number of first-time home buyers who would logically purchase ‘starter’ homes, the remaining homes being sold would be skewed to the upside, as they would represent older, more established buyers seeking larger homes.

That’s my take on these numbers.  It’s not much of a scientific analysis, but it is at least supported by reason….unlike the September sales data out of Vancouver.

Cheers

Ben

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2 Responses to Statistical aberration or ‘the new normal’?

  1. Bobmatou says:

    While observing the French housing market, I noticed the same weird trend when the market started to slow down: a lower number of sales and a higher average price.

    The most documented analysis I read at that time explained that the ”bad products” that usually are sold at a lower price would not find buyers anymore whereas so called ”good products” would still find a market for a while. Event at a strong price, RE agents would still push them as nuggets, good opportunities that are not easily to be found, and people would be lured into buying them. As a French RE agent told once in an interview ”regarding housing, a turkey gets up everyday” (Turkey should be translated by Fool but I’m sure you catch the idea there).

    The combination of cheaper ”bad products” that didn’t sell and more expensive ”good ones” was, according to that analyst, the main reason why average prices were still going up. The whole analysis was backed up by a lot of data, the guy himself had a lot of credibility in housing. I can’t find the article, which would sadly for you be in French, but I’m pretty confident that the guy who wrote is Vincent Bernard at http://www.objectifliberte.fr/

    If I recall correctly, what he stated was that this trend is very common in housing and also profoundly unsustainable ; and that it’s one of the latest steps before market correction. The illusion of a good opportunity that you can’t miss remains for good products, but it won’t last when housing will be entirely seen as a bad investment decision by everyone.

    Hope it makes sense as I’m not a native English speaker.

  2. Ray says:

    Don’t you just graph homes sold $450k-and-up versus $450k-and-lower to show that the averages are from the former and not the latter?

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