Monday, May 11, 2009

The market drivers

In my last post I told you how RE has become a lot more affordable due to the 15% drop in prices from the peak and the drop in mortgage rates.

These two factors have reduced the cost of owning property by between 30-40%. No small amount.

Add this to the normal seasonal factors and the current strength in the market, which seems so inexplicable to many bloggers, is obvious.

Does that mean we are off to the races again and should expect double digit appreciation?

I don't think so. Why?

The economy will trump everything. In the US they had the same metrics and housing only stabilised temporarily before resuming it's downtrend.

Of course the US had crazy 0%-down, neg-am, interest only, no-doc mortgages which helped bring their house of cards down. We are not in such a bad shape, but we do have a lot of people who have got in way over their heads in upper and lower end RE. We are also very dependant on resources and the construction and service industries (eg building and selling houses to each other) and have a higher median age than Ontario or any other Western Province.

We are in a major recession, with more lay-off coming and if the economy doesn't turn soon, 'we could see a race for the exits', as some owners are forced to sell..

As the economy weakens, two factors will impact RE prices. Wages will not rise and family income drops as unemployment increases. So while affordability is increased, it may be cancelled out by lower income.

Secondly rents are likely to stagnate or even drop. Therefore the rent/buy comparison I made a few posts ago tend to favor renting, where costs are fixed- whereas owners will face the increased costs of repairs, increased taxes and changes in interest rates.

It may seem to my readers that I am arguing both sides of the coin, saying how much more affordable RE is in one post, how renting and owning are becoming comparable in another post and then explaining how I still think prices will fall further.

The truth is, there are many cross-currents affecting RE, as with any other investment, including some I haven't thought of, which may in fact be the critical ones!

However look at the housing boom of the last 7 years.... As affordability became more stretched, the bears became more convinced that a correction was inevitable. That was 2004! It caused a small drop and then we had fours more years of sizzling hot price inflation.

By 2006 I remember bears frothing at the mouth on the news that 50%+ of income was needed for housing costs. Sure enough there was another small and very short-lived blip down then, too. But by 2008, it had reached nearly 70%. Momentum and a speculative boom overwhelmed the lack of affordability much to the bears disbelief. (me included)

You can see the very short-term dips in 2004 and 2006 on this chart:

Now we have the opposite. Increased affordability has stopped the market from dropping, but the negative momentum and uncertainty will likely overcome the short-term stabilisation.

I think we have moved from a bull market in RE, ( and stocks) to a bear market in both. Both will have a bounce, but I think they will both eventually go lower.

At least that's how I see it. However, as I mentioned, there can always be some other factor which unexpectedly changes the equation. You can only make the guesstimates based on the information you have available. If I see a very strong summer/fall in RE and a solid turn around in the economy, then I will have to re-evaluate my theories. I don't expect either one.