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Friday, July 5, 2013

Home Prices in Toronto - History




 In the last 40 years we have gone with an average house price of $32,513 in 1972 to a whopping $497,301 in 2012.

It is over 15 times the difference in price.

During that time Ontario's minimum wage has gone from $1.65 in 1972 to $10.25 in 2013 - a difference of 6.2 times. So housing prices have skyrocketed a whopping 15 times, while the minimum wage has scarcely gone up.

What about per capita GDP?

Canada's per capita GDP (the average earnings per Canadian) was $13,320.19 USD in 1972. In 2012 it was $25,933.29 USD. [Source http://www.tradingeconomics.com/canada/gdp-per-capita ] So our GDP per person has effectively only doubled in the last 40 years.

And yet house prices in Toronto haven't doubled. They've gone up 15 times.

The average price of a Greater Toronto Area (GTA) home was just $21,360 in 1966. Can you imagine how comparative cheap that was? Last year, on average, homes in the GTA cost $497,301. That means that GTA homes are 22 times more expensive than they were 45 years ago.

And during all this time we've only seen ONE real estate bubble burst back in 1990, with a low point in 1996. During that 6 year period prices dropped an average of $56,870 - roughly 22.3%.

If we were to encounter a similar drop in the near future - from a high point of roughly $500,000 - then the average price would drop to $388,500, which would be back down to 2008 levels, back when the Great Recession in the USA was going on due to the bankruptcy of many mortgage investment companies (and the bailout of several of the larger companies who were considered to be "too big to fail").

Now of course if the real estate bubble in Toronto burst it wouldn't drop the exact same amount. If anything it would drop a lot more than that because Toronto has almost no manufacturing and has a mostly service based economy - which means when profits dry up many companies that provide services would simply layoff huge numbers of staff to make up the difference.

For example when the condo bubble bursts in Toronto the construction of new condos will grind to a halt. Construction workers will be laid off. Those construction workers will have less money to spend + many people who put money into unbuilt condos will lose a chunk of their savings. Those people will then spend less and cut back on things like services. Thus begins the whole downward spiral. If you've studied economics I don't need to go into great detail.

Playing with Numbers

The reality is that the cost of housing in Toronto has reached such a high price that is now well-night unaffordable. Families are going into huge debts just so they can buy a house that they can barely afford on their current salary.

Back in the early 1980s it wasn't so bad... even though the mortgage interest rate was 22% in 1981 (that is not a typo, it really was 22 per cent) people could still afford to buy a house and raise a family because the costs of houses had not yet skyrocketed to such idiotic proportions. The average price of a Toronto house in 1981 was $90,203. It was a very reasonable price at the time and people didn't mind paying the huge interest rates because it was so darn affordable.

In contrast the mortgage interest rate in Canada in 2012 was hovering just under 3%. Low interest, but outrageous house prices.

Lessons from History

If you put both of the above charts side by side, patterns will start to emerge. At the end of 1979, the prime interest rate sat at 15.25 per cent - a shocking number by today’s standards. By the end of 1980, however, that number had risen to 20.5 percent. Home sales and home values skyrocketed from $70,830 in 1979 to $90,203 in 1981. They rose even further in 1983 to $101,626. As a direct result of rising interest rates, sales rose. The mentality at the time was something along the lines of I-better-buy-a-house-before-prices-get-worse.

The rising interest rates and rising home prices were scaring people into buying a house ASAP. Today it is the opposite, people are scared about a possible crash - but they are buying houses at ridiculous prices because they've got their head in the clouds thinking that the government will somehow save them even if a crash does come. We've taken the lessons from 2007 and turned it into a safety blanket and a false sense of security - forgetting all the while that over 13 million Americans lost their homes during the Great Recession and the government did nothing - absolutely nothing - to stop it from happening because they were too busy bailing out the banks instead.

Back in the early 1980s with interest rates as high as they were, it’s no wonder that many families struggled. As interest rates rose, more and more families lost their homes because they couldn't afford the rising cost of payments. But the percentage of people losing their homes during the 1980s was nothing compared to what happened during 2007 to 2009.

By the mid-1980s, interest rates dropped dramatically. While the prime interest rate hovered just above 20 percent in 1980, by 1984 it had dropped to 13 percent. (Note! Mortgages rates are often 1 or 2 per cent above the prime rate.)

The prime rate dropped even further in 1985 to 9.5 percent, and even 7.5 percent in 1986. As interest rates dropped, the dream of home ownership became a realizable goal to many. As a result, more buyers entered the market, creating more competition, and housing values rose substantially - the start of a bubble.

In 1985, for example, the average home in Toronto cost $109,094. A mere two years later, that number rose to $189,105. That is a huge jump in two years.

The recession of the early 1990s lowered over-inflated home values. While the average price of a Toronto home in 1989 was $273,698 (prime rate was 11.5 percent), by 1992 that number had dropped to $214,971 (prime rate was 6 percent). Both prices and interest rates were dropping because the economy was considered dire at the time.

It’s weird because the market conditions often depends more on MOOD than anything else. First interest rates went up in order to curb spending; then they’re dropped to encourage spending. It’s all just playing with the numbers in an effort to balance the economy and the needs of people.

Fast forward to the present. Ridiculously low interest rates and ridiculously high home prices. But we're too afraid to raise interest rates quickly because we're afraid it might hurt the economy.

At the beginning of the economic recession in 2007, we saw home values in the USA drop 40 to 50% in some places. Interest rates dropped to ZERO during the collapse. It was basically free credit. It was done in order to help boost spending.

At the same time, amid the chaos, America was also suffering under a housing shortage - like Toronto currently does. The shortage under normal circumstances drives up prices - often to ridiculous levels. But during a crisis the shortage becomes a stop gap from prices dropping too much because there will always be people who realize, hey-if-I-buy-now-the-prices-are-pretty-nice.

While one could conclude that the housing market follows a pattern and is, therefore, predictable, it isn’t always as easy as that. We are really just guessing.

For example I am guessing that Toronto's condo market will suffer a collapse in 2015-2016 and prices will drop roughly 30 to 40 per cent because of all the overseas investors losing their shirts - and I am basing that number on the fact that condo builders are building a surplus of 40% more condos that will all hit the market in a two year period.

Many economic predictions are proved incorrect. Many of them are off by anywhere from 10% to completely contradictory if something completely illogical manages to happen. Interest rates might rise. Housing prices might fall instead. Condo prices might skyrocket. It is possible I suppose, just highly unlikely.

Conclusions

Buy low, sell high. Interest rates may rise and fall, but nothing beats a house bought at a decent price.

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