Primer #7: Housing envy and the ‘Joneses’…How a realignment in consumer expectations will pull at aggregate house prices

“A house may be large or small; as long as the surrounding houses are equally
small it satisfies all social demands for a dwelling. But if a palace rises beside
the little house, the little house shrinks into a hut.”
–Karl Marx

Conspicuous consumption and the new consumer culture

It was Thorstein Veblen who first coined the term ‘conspicuous consumption’ in his 1899 book The Theory of the Leisure Class. The term is now broadly applied to any spending pattern that places value in an item primarily for its ability to convey social status rather than for the intrinsic value of the item itself.

In other words, people buy things to maintain a certain image rather than for the actual value of the item.  And since our consumption patterns are perceived to be a reflection of our income or assets, the greater the consumption, the greater the perceived status.

In one of the great personal finance books The Millionaire Next Door (I highly recommend it), researchers Stanley and Danko brilliantly demonstrate that conspicuous consumption is not a hallmark of the truly wealthy.  Rather it is much more likely that people in lower socioeconomic classes will increase their consumption relative to their incomes in an attempt to appear to have a certain measure of wealth.  Those whose incomes put them in higher socioeconomic classes and who chose to engage in conspicuous consumption to show this typically have much lower net worth than their salaries would suggest.  These same people often have great difficulty sustaining that lifestyle into retirement.

Let me restate that since it is critical to understanding the main point of this post:  People who are conspicuous consumers set themselves up for difficulty in maintaining that lifestyle and eventually have to take measures to correct it.

When conspicuous consumption becomes prevalent in a society, it becomes a feedback loop in which individuals increase their consumption to increase their relative status, but with the net result being that consumption rises but no one is actually better off, either materially or in their relative social status.

Conspicuous consumption and the McMansion culture

There is little doubt among academics who study the psychology of conspicuous consumption that housing is one of the most powerful symbols of status in North America.  Home ownership carries with it a certain status, while a prominent stigma exists towards renting.  When housing as a form of conspicuous consumption is embraced by a large swath of society, the results are predictable.  As Robert Frank noted in a New York Times editorial, “when everyone builds bigger, the primary effect is merely to raise the bar that defines the size of home that people feel they need.”

This raises certain questions with regards to the Canadian housing market:

1)  How prevalent is the ‘keeping up with the Joneses’ phenomenon in Canada? One way we might explore that is to examine how the average house has changed in Canada over time and then compare these changes to what we might expect given the change in demographics.

2) If housing represented a form of conspicuous consumption, we might expect to see evidence that people are going to greater and greater lengths to attain that status symbol.  For example, we might expect a steady erosion in the price-to-income and price-to-rent ratios for houses in Canada.  Similarly we might expect to see a rise in home ownership rates that cannot be accounted for by an aging population alone.  That is to say that we would expect to see a rise in home ownership rates across all age groups.  Is this happening?

3)  If housing has become a social symbol and we have become a society that has embraced a skewed view of housing, will this last indefinitely?  If not, what would a realignment of consumer expectations do to aggregate home prices in a stable demand environment?  What would it do in an environment where demand diminishes and the credit necessary to purchase these large homes is simultaneously squeezed via either rising interest rates of tightening standards?

1)  Are Canadians trying to keep up with the Joneses?

This is a key question in this whole discussion.  Has our perception of what constitutes a ‘comfortable’ house significantly changed over time?  The answer is a categoric ‘yes’!

CMHC calculates that in 1975 the average single family home in Canada was 1050 square feet.  According to the Canadian Home Builders Association, in 2010 the average new single family home in Canada was 1950 square feet….nearly double what it was just 35 years ago.

Interestingly, the size of new single family dwellings actually peaked in the mid 2000s at approximately 2300 square feet and have since fallen to under 2000 square feet, possibly signaling that a shift away from the McMansion era is already underway.  Even at the current 1950 square feet for the average new house, do demographics support a demand in these homes going forward?

If we look at the change in household characteristics, we find that in 1971 the percentage of households that were either ‘one person households’ or ‘couples without children’ totaled 35%.  These are households with a maximum of 2 occupants in the dwelling.  In 2006, that percentage totaled 53%.

During that same time frame, the average household size has fallen from 3.5 to 2.5.

Despite a significant rise in the proportion of 1 and 2 person households and a significant drop in average household size, the average square footage single family homes in Canada has risen markedly over the past 40 years.

Now there is a limitation in the data.  We know that condo developments have been one of the fastest growing dwelling types.  How many of these 1 and 2 person households have taken to living in smaller condos and not the ‘McMansions’ we’re concerned about is worth considering.

But even if we assume that this it’s true that many of these households are embracing condo life, in order for this trend to exert zero price pressure on aggregate house prices we would have to assume that there will remain a stable demand for large homes as these households will ultimately need someone to sell to in order to be able to make the move.  I have my doubts that this will be the case.

2)  McMansions as conspicuous consumption

As noted above, if in fact Canadians are increasingly seeing their home as a status symbol, we might expect to see several trends:

  • Erosion in the home price-to-income ratio:  As consumers increasingly embrace home ownership across a society, the natural repercussion is for all consumption to shift higher.  Where 50 years ago a 2000 square foot home was a symbol of very high socioeconomic standing, today it is no more than average.  As a result, 5000 square foot homes are arguably the new wealthy standard.  In order to classify real estate as a new status symbol and a form of conspicuous consumption, we would expect to see people stretching ever further to attain it.  Alas, the recent report from TD sheds some light on how this ratio has changed over time.  Indeed we see a steady increase in home prices from the relatively stable long-term mean of 3-3.5 times income last seen in 2001 to 5.9 times in 2010:

Depicted as a line graph it looks something like this (as calculated by the Bank of Canada)- Note the ‘bubble’ of the late 1980s which ended in an abrupt realignment in house prices with incomes followed by a decade of stagnant growth:

  • Increase in house prices relative to rent:  If people increasingly embrace home ownership and shun renting, we might expect to see that the price of a dwelling rise over time relative to the rent it would receive.  Indeed this is very much the case as the home price-to-rent ratio for all of Canada has never been higher:

  • A rise in home ownership rates across all demographics:  If home ownership has become a status symbol, we might expect to see a rise in ownership rates.  However, as our population ages we might expect a natural increase in ownership rates regardless.  The smoking gun would be a rise in ownership rates across all demographics (though it is worth noting that while the average aging of the US population is similar to that of our own, their ownership rate has dropped from a high of just over 70% to its current level of 64%).  Let’s start with the total home ownership rate in Canada:

  • We are now very near or even above 70% ownership rate.  This alone suggests pressure on future house prices.  With total population growth expected to slow to 1.5% by 2015, it begs the question of who will continue to buy the homes that people will need to sell as they age and eventually find the upkeep overwhelming.  But as I said, we would need a smoking gun of a rising ownership rate across all demographics.  Here it is courtesy of Stats Canada:

  • Despite some variability along the way, every single age group has a higher home ownership rate today than in 1971.  Enough said!  Together with the massive change in home prices relative to incomes and rents, it suggests that there is a strong psychological element that is sustaining real estate prices.  Indeed this was explored in an earlier primer where we saw that bullish sentiment on real estate in Canada prevails by a large margin.

3)  The future of the McMansion:  Demographics set to squeeze Canadian real estate on several fronts

The demographics are certainly troubling.  I’ve explored the potential repercussions of our current demographic on long-term house prices in an earlier primer.  In that post I suggested that the data indicates that there is a substantial number of near-retirees who are planning on accessing the equity in their home to partially meet the funding need in retirement.  Yet how a large group of them will be able to do that if demand for large homes begins to wane is perhaps the trillion dollar question.  Even the reverse mortgage option has its limitations if the value of the home begins to drop.

Over half of the average net worth of Canadians is tied up in real estate.  I suspect that the median number is even higher as the very wealthy have a disproportionate amount of wealth in their business or other investments while real estate typically accounts for a smaller share of their net worth.  An article in the October 2010 issue of the Journal of Financial Planning indicated that equities are still overwhelmingly the investment of choice among high net worth individuals.

Ultimately, the numbers used in my primer on demographics don’t prove anything, but they do hint at a prevailing sentiment:  That real estate is expected to fund the retirement of a portion of near retirees.  But demographics are currently set to disappoint many people.  The only thing driving the current demand for houses is the prevailing psychology or consumer sentiment of the times….itself notoriously prone to sudden and permanent shifts.

Virginia Tech economist Arthur C. Nelson has calculated that North American households with children will fall from 50% to closer to 25% of all households by 2025.  There is little doubt that demand for large homes will remain subdued as this plays out.  Nelson has suggested that over the next 15 years, demand for larger single family homes will decline by 40%.  This assumes a stable demand environment to begin with.  That is to say that the demand for all housing types will remain constant with a shift in demand towards smaller, urban dwellings.  It holds that price pressure will result in such an environment.

But what if demand broadly declines?

The impact of a ‘credit squeeze’ on house prices

Houses have become a status symbol and have been allowed to rise in price primarily due to the prevailing direction of interest rates over the past decade and the prevailing trend in lending standards over the same period.  At this point interest rates can not fall meaningfully from their current levels, but there is a whole lot of room to move upwards.

Remember that each increase of 1% in interest rates amounts to a 9% increase in mortgage payments.  Even more importantly, each 1% increase in mortgage rates also reduces the amount of available credit that can enter the system, as the incomes of new home buyers can now support less and less mortgage debt.

The stability of a housing market and the subsequent ability of people to unload their large homes at their current prices depends on the availability of adequate credit in the system and the abundance of new buyers entering the system.

While the rate at which interest rates will rise may be debatable, their ultimate direction is not.  So in addition to interest rate pressures which will cut the amount of new credit entering the system, we also are entering an era that is fundamentally opposite to the one that has prevailed over the past decade:  An era of tightening lending standards.  CMHC loosened their lending standards over the past decade.  However, as of mid March we will see the second tightening of lending standards in the past 12 months and the third since 2008.  Exactly what effect this will have is certainly debatable, but there is no denying that this will act as a downward pressure on credit expansion going forward.

In an environment where available credit is falling, the McMansions will be hit hardest.

Changing consumer psychology = bad news for house prices

It’s worth noting that aggregate house prices could fall significantly even in the presence of sustained demand IF that demand shifts away from the McMansions of today and back towards a more conservative sentiment towards housing.

But with house prices sitting at precarious levels when compared to measures of fundamental value, it’s worth exploring what might happen to consumer psychology should house prices fall significantly.  Although I don’t expect a US style correction, I absolutely can envision a 25-30% decline in aggregate national house prices, pulled lower by carnage in a handful of particularly bubbly locales.  While not the US experience, the pain would nonetheless be acute.

How have Americans adjusted their expectations as they have seen house prices fall?

Americans want smaller homes, not McMansions– USA Today: August 25, 2010

Bye, McMansion. Americans go for smaller homes– New Urban Designer: October 13, 2010

Americans are moving on up to smaller, smarter homes– USA Today: March 17, 2009

American dream shrinks as smaller homes gain favor– USA Today, December 2010

There are literally hundreds of articles examining this new and prevailing consumer mentality towards homes.  While some articles point to economic reasons underlying the shift, I would suggest that the reason is overwhelmingly psychological:  People are simply reevaluating what they consider needs and wants.  We would be foolish to assume that such a reevaluation is not possible here in Canada.  Indeed it is outright probable.

Conclusion

The McMansion era is coming to an end in Canada as it is in the US.  This will occur either by a voluntary realignment in consumer perceptions or via a lid on credit expansion and unstoppable demographic trends.  This post has not even delved into the impacts that a rapid rise in fossil fuels and heating costs would have on demand for larger homes, or how the demand for such homes will change in the face of the inevitable raising of property taxes to meet spending requirements at the municipal level.  Needless to say, they will add downward pressure as well.

While I believe a significant nationwide housing correction is in the cards, the pain will most acutely be felt in the segment of the market we might term as the McMansions.  This will be the segment of the market that will turn stubbornly illiquid first and remain illiquid the longest.  While these homes may not constitute mansions by today’s standards, they certainly represent a massive expansion in society’s perception of ‘normal’.  Perception that may well experience a conservative shift as the ebb and flow of consumer expectations inevitably change the demand landscape.

Cheers,

Ben

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45 Responses to Primer #7: Housing envy and the ‘Joneses’…How a realignment in consumer expectations will pull at aggregate house prices

  1. Mike says:

    Frequent reader, seldom commenter, but this was great. Thanks for taking the time to construct a clear and concise post (and wicked graphs). While there are countless variables in the RE market it gets harder to ignore some of the bigger ones that aren’t sustainable (debt, interest rates, demographics).

  2. John in Ottawa says:

    Bravo! Excellent work!

  3. Jordan says:

    I think that the energy factor is huge. Twice the square footage means twice the volume of air that needs to be heated. Even though newer homes are more energy-efficient in most cases, the added costs can be very large. Throw in things like a penchant for pot-lights (at 50 W a pop, they add up) and trends in the electricity market and you have the makings of a real disaster.

  4. Lievertising says:

    Great post!

    Daily reader and enjoy your perspectives. I welcome this coming change. There are too many gold diggers and people trying to keep up with the jones.

    There is definitely a moral shift going on in consumers as well that is creating a less is more society.

  5. TS says:

    Great post and the household number also helps supports the reduced sales of new single family homes. The other reasons are lifestyle choices are changing. Recently arrived immigrants do not demand as much space as Canadians. Young people choose smaller space and lifestyle downtown Toronto offers. That may be saying something about future housing formations. The conspicious consumption purchase is not healthy.

  6. Mango says:

    Your “lifestyle” point is DEAD WRONG, others are basically re-used from other posts

    I would suggest that you are DEAD WRONG. Basically, people will go to any lengths for lifestyle spending (anyone here get hurt shorting LULU, Starbucks, Whole Foods, etc)

    I can sell Organic XYZ at any premium and people will buy it, But Bra pants, people pay up, piss in a Starbucks cup, people pay. Remember, you are taking on a fundamental way of thinking, a lifestyle, not a graph of a rising line in which you feel an inflection point exists.

    It is very hard for people to re-think these choices and lifestyle habits almost need a depression to break. Look at the US consumer spending, it continues and they have all sorts of debts and problems. A house if you believe is a lifestyle choice, then people will “shift” money from other things towards it. I see it every single day.

    • ATP says:

      Mango, please say ‘Hi’ for me to Mr. and Mrs. Jones, your next door neighbours. Thanks.

    • SuperPL says:

      You are partly correct. While I agree that a premium product always has a premium buyer, you are expecting everyone to buy at such premium to maintain a a lifestyle and that is incorrect. People trying to up keep a lifestyle will shift money away from other things at the beginning, such as skipping a BMW for a Honda, this eventually ends as there is nothing left to shift away from; and the lifestyle changes or the person goes bankrupt.

      Maybe you should think what will happen as people start to shift money from lifestyle to support their taxes, food, transportation and kids….

      • Mango says:

        “this eventually ends as there is nothing left to shift away from; and the lifestyle changes or the person goes bankrupt.

        Maybe you should think what will happen as people start to shift money from lifestyle to support their taxes, food, transportation and kids….”

        Shift is re-allocation of the same $ pie, not over-extension. Think about it. That is not taking you to go bust

      • SuperPL says:

        How about you think about it; if I need to allocate a larger portion of my $ pie elsewhere, that means my lifestyle $pie portion needs to get smaller, or you go bust 😉

  7. pricedoutfornow says:

    “…equities are still overwhelmingly the investment of choice among high net worth individuals.”

    YES! I work in the financial industry and thus have information about individual’s wealth. Interestingly enough, I have noticed that the vast majority of our high-net worth clients HAVE NOT participated in this real estate bubble. That is, they did not take out massive amounts of debt in order to secure real estate. Meanwhile, our middle-class, average-joe clients have been telling me for years that “the only way I can get rich is by buying real estate” (with 35 year, 5% down). Some of them are now on the verge of losing their shirts.
    That’s why I haven’t bought yet…live and learn.

  8. Declan says:

    Good post. These days so much of our consumption is relative (done for status) rather than absolute (done for personal comfort/convenience), I think that is a reason why people feel they keep falling behind even though objective measures suggest incomes have risen (somewhat) over the past generation.

  9. SDBound says:

    Ya one can argue avg home is now larger. But in cities like Vancouver you now have 3 to 4 households crammed into a single detached home. Talk to any new spec builder and you find every new home now built with two basement suites at a laneway house. So while avg new home is over 2000sf, the home owner is actually only living in less than 1000sf. In some cases even less because they live in the basement and rent out upstairs in order to get enough rent for paying mortgage.

  10. Michael says:

    Don’t forget that the term McMansion was coined for overly large houses on small plots. The increase in house prices is mostly due to land costing more not to construction costs that tend to track inflation.
    When house prices drop you get more land but don’t need to overbuild. So the trend against McMansions is just normality.

  11. backwardsevolution says:

    Another great post! Thank you, Ben.

  12. TS says:

    Smart growth policies caused the land to increase thanks to lack of supply. Condominiums keep getting smaller and smaller. I remember someone comparing this to taking a cheerio and making the hole bigger. We no longer seeing rising prices in the 905 area for singles. Those days are over. The Province of Ontario’s answer to affordable housing was to make basement apartments legal. Real bright policy. That pushes single family home prices up by opening demand with this ridiculous credit market. CMHC and Provincial policies just love to push prices up. Ask your self why? High housing prices are not good for our nation. We are suppose to be globally competitive. Higher prices also cause traffic chaos. West end of Toronto has the jobs yet the average median household wage cannot afford to live there.

  13. dogman01 says:

    Great Post
    SDBound may be on to a trend, Calgary is debating making secondary suites much easier (regulation changes). Calgary is a sprawl of costly McMansions; secondary suites will help with density and covering the costs.

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  15. Steve says:

    Why can’t I “like” this blog on facebook yet? 😛

  16. AG Sage says:

    >Although I don’t expect a US style correction, I absolutely can envision a 25-30% decline in aggregate national house prices, pulled lower by carnage in a handful of particularly bubbly locales.

    25-30% *is* a U.S. style house price correction. The Case Schiller 20 city is at 30.3% right now. If you add in the bulk of smaller cities (like mine that had almost no bubble) it’s lower. (Zillow for example estimates 26% declines for the whole country.)

    Yes, the U.S. has farther to fall, but part of that is follow-on, driven by the resulting recession. Canada is not immune from that either, especially considering the reliance on commodity prices.

    So, I guess the 64,000$ question is: are you predicting a U.S. style decline in Canada? 😉

    If this seems nit-picky, I apologize. That line I quoted above really threw me, is all.

    • Hi AG Sage

      I actually thought about that before posting it. I realize that a 25-30% drop is in the ballpark of the current US experience. In my mind US average house prices still have a ways to fall. So while it would put it at the current level of carnage in the US, by the time everything plays out I think we’ll see a substantial difference in the peak-to-trough declines between the two countries.

      • AG Sage says:

        I had a feeling that was your thinking. But you weren’t explicit. Maybe if you had said something about expected total declines.

        As always, your post is good reading. Houses becoming a luxury good would be a good bubble meter.

  17. data junkie says:

    Interesting how the CPI coming in marginally lower than expected has everyone piling back into Canadian bonds, as if there’s no possible way Carney will raise interest rates for the forseeable future.

    If my pension fund started buying up 5 year bonds at this point in time, I would firebomb the manager’s Range Rover.

  18. SDBound says:

    My point is they r taking detached properties and effectively turning them into multiplexes. The city shouldn’t allow this, but instead encourage more development
    of real apartments, row houses, and multiplexes. After all, the guy is getting taxed
    as a single detached house but there’s 12 people living on the property or more!

    • Ts says:

      Yes and those subdivisions were never designed for that. The depression had many of these places. Called rooming houses. Changes the character. Parking can be a problem. Pits neighbour against neighbour. Stop parking in front of my home arguments, I want visitors. It sure helps support someone that paid too much for there home though and maintains some kind of value for a while till the neighbourhood has more rooming houses than single family houses.

  19. vreaa says:

    Thanks; great post, Ben.

    Wow, ‘one-person’ share went from 13% to 27%.
    One can imagine that number shrinking back with a bust.

  20. Dave says:

    “The term is now broadly applied to any spending pattern that places value in an item primarily for its ability to convey social status rather than for the intrinsic value of the item itself.”

    Not only does this happen with houses it trickles down int , cars, clothing, eating out, handbags even kids that are way over scheduled due to the fact that parents want little Johnny or Jane to be involved with everything.

    A prime example of promoting this life style is the Housewives of New York / Orange County / Atlanta.

    Great site by the way. I love the practical point of view as opposed to the self perpetuating spin that the real estate machine turns out.

  21. ATP says:

    Ben, on the “lifestyle” point that you were accused of being DEAD WRONG about:

    Borders, a US book store/cafe chain, filed for Chapter 11 this week.
    I used to go to their stores quite a bit when I was living in the US. Not a bad place at all to read while sipping coffee.

    http://www.bloomberg.com/news/2011-02-17/borders-ambac-terrestar-point-blank-mers-bankruptcy.html

  22. Play nice. You’ll wear out your welcome pretty quickly if your only reason for coming here is to insult people.

  23. sheldon says:

    square footage in Manitoba is different than BC….In MB you have a full basement that is NOT included in the living space sq. ft. In BC as I have found out by moving here there are NO basements so the total area is counted as living space….You need that so called EXTRA space to live the same as I did in MB.

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