Housing Bubbles Are Unsustainable Changes in Price

July 24, 2012 / Russell Legato, Residential Property Analyst

Housing bubbles are not apparent and sometimes cannot be observed until they burst. A housing bubble is not a reasonable entity. It typically begins as a price increase pulling people in and causing them to be eager to purchase a property. This happy state continues until a financial crisis occurs. People may then panic as the prices go down and they realize the bubble has burst.

Housing Bubbles Are Unsustainable Changes in Price

Houses in all of Canada saw an average eight percent decrease, followed by a recovery in 2010. Now prices are twice what they were in 2002. In Victoria, Toronto and Vancouver, the rise was considerably faster. Did the conditions there constitute a bubble? When measured in two ways, they did.

The two ways are an affordability ratio that determines how high an income is required to qualify to buy a house. At that time, lower prices become probable. This ratio grew faster in Canada than any other developed nation. The second measure is a cost to rent ratio, which is the cost of buying a home as it relates to annual rent. This ratio in Canada is up by 20 percent, one of the most rapid increases in developed nations.

A leading Canadian expert stated that there is a tendency to overvalue houses by a whopping 76 percent as compared to rents and 32 percent as compared to income. That equals an overvaluation of 54 percent. We certainly have learned that these bubbles can burst like transient dreams.

Finland is a prime example. The cost of a house there nearly doubled from 1987 to 1989. Then by 1992 prices were 50 percent lower than that peak. Every bubble, has a peak and fall that is relative to the conditions that existed to begin with in each case.

History relates many instances of bubbles bursting. Japan saw it happen in the years between 1985 and 1990. The decline was greater in Britain, 20 percent and Spain 25 percent. In the U.S. the drop was over 40 percent and 50 percent in Ireland.

These extremes are almost impossible to predict. Caveat emptor should apply to real estate purchases in this regard. However, it is hard to be warned when these bubbles are so unpredictable.

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