The Toronto housing market was in a precarious place in the late 1980s. Prices had doubled in a short period, households were piling on debt and the market showed no signs of slowing down. That period represented a peak for Toronto (prices crashed in 1989) but by today’s standards, it looks absolutely quaint. The average home price was a mere $469,000, amounting to 5.4 times the average income. These days, the average home price is between seven and eight times income. To return to the ratio of the 1980s, the average household income has to jump to $160,000, or home prices have to fall back to $460,000.
There is a third possibility: this time is different. Maybe prices in Toronto and the surrounding suburbs really have reached a new normal, and a wide swath of people are permanently shut out of the market. “There is no particular reason housing has to be affordable for the average person,” wrote Ernest Wong last month, a research analyst with Baskin Wealth Management. Toronto is still cheaper than cities such as Hong Kong, he argued. “Despite being increasingly unaffordable for new home buyers, the current expensive housing prices are rational, and should be expected in the low interest rate environment.”
This line of thinking could be classified as a “this time is different” argument, which is used by investors to justify what turn out to be unsustainable market trends. In this case, house prices are not headed for a correction because, unlike in previous cycles, low interest rates allow people to hold bigger mortgages and purchase more expensive houses. It’s one of many such reasons put forward to explain rising home prices in Toronto and Vancouver, including tight supply and foreign demand. Those assumptions are now being put to the test. Both cities are cooling—according to Realosophy, sales of freehold houses in the Greater Toronto Area are down 26 per cent over the past month—and prices could follow. We may soon find out just how different this housing cycle really is.
Investment guru John Templeton is known to have remarked that “this time it’s different” are the four most dangerous words for investors. Economists Carmen Reinhart and Kenneth Rogoff published an entire book on the subject in 2010 and examined eight centuries of financial disasters. They found “this-time-is-different syndrome” pops up again and again. “It is rooted in the firmly held belief that financial crises are things that happen to other people in other countries at other times,” they write. “We are doing things better, we are smarter, we have learned from past mistakes. The old rules of valuation no longer apply.” The current boom, they go on, “is built on sound fundamentals, structural reforms, technological innovation and good policy.”
Reinhart and Rogoff include an 1929 ad from a U.S. ratings agency. “Today, it is inexcusable to buy a ‘bubble’—inexcusable because unnecessary,” the ad copy reads. Investors of the day possessed a wealth of facts about stocks compared to the punters of decades past, which “eliminate the hazards of speculation and substitute in their place sound principles of investment.” The stock market, driven by a speculative frenzy, crashed that year. The Great Depression ensued.
A similar phenomenon happened during the dot-com bubble in 2000. The internet was poised to revolutionize the world, and some spoke of a “new economy” where the old rules didn’t apply. Tech companies with no profits (or even much of a business plan) soared to extreme valuations that were justified, in part, by the belief that future profits would be made faster and that equities were less risky than in the past. Investors purchased shares at ridiculous prices in anticipation of prices rising even higher. It turned out profit still mattered a great deal. When even well-established tech firms started missing earnings expectations, investors panicked and another stock market crash followed.
A new reality was used to justify triple-digit oil prices a decade ago, too. Peak oil theorists contended that cheap and easy energy was running out. The black gold left in the ground, such as in Canada’s oil sands, was more difficult and costly to obtain. In 2008, Jeff Rubin, then an economist with CIBC, predicted the price of oil would hit $225 a barrel in four years. He later quit his job at the bank to pen Why Your World is About to Get a Whole Lot Smaller, an extended argument for how expensive oil would bring globalization to a halt. Since then, new technologies have unlocked previously hard-to-access oil and gas reserves, and the global economy has been growing at a sluggish pace after enduring a deep recession. The price of oil came back to earth.
The logic in each case wasn’t entirely flawed, however. Investors did indeed get more access to financial information, the internet did change the world, and non-traditional oil and gas comes with higher costs. “Every bubble begins with a good fundamental story,” says Doug Porter, chief economist at BMO Financial Group. But people then take sound economic trends to an extreme. “Investors extrapolate a good thing into something that can never go wrong—until it does,” Porter says. A robust body of research exists to explain bubbles, and many of the reasons come back to human nature. We can rely too heavily on past returns to predict future performance, seek out information that confirms our beliefs while ignoring counter-arguments, and fall victim to group-think and our own hubris.
When it comes to the housing market, there are solid fundamental reasons to explain the booms in Vancouver and Toronto. Vancouver, for example, is a land-constrained city and an attractive destination for foreign buyers. But to assume prices will keep rising as a result misses an important point, says Josh Gordon, assistant professor at the School of Public Policy at Simon Fraser University. “In bubbles, people underestimate the elasticity of supply,” he says. Higher density housing can substitute for detached homes, for example. “Eventually, supply will catch up to that surge of demand. When that happens, you can have downward pressure on prices.” The trouble is supply constraints are glaringly obvious in the short-term, exacerbating the demand frenzy and reinforcing the notion that prices will go higher.
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Similar arguments have been put forward to explain Toronto’s house prices. An article in the Globe and Mail sums it up: “Mortgage rates are low. Ontario’s economy is superheated … and, to make matters worse, land is in short supply,” according to the piece. “Politicians and tenants’ groups have declared a housing affordability crisis—again—and have called for a tax on speculators’ profits to cool down the frenzy.” The article continues, “Dark words are muttered about how foreign money is to blame.” Other reasons are cited, too: Toronto is becoming a “world class” city and “acts like a magnet for thousands of migrants from elsewhere in Canada and overseas.” Instead of stocks, “owning a house is now the investment of choice for most of the middle class.” The unlucky masses priced out of the city are looking as far afield as Barrie, Ont. for a home.
It’s probably worth mentioning this article was published in 1988—just before the crash. Yes, all of the same arguments we hear today were made nearly 30 years ago on the eve of a painful real estate correction. So are we doomed to repeat history?
Porter says that not only are interest rates lower today, foreign money is playing a bigger role than in the 1980s. That’s not fully captured in the price-to-income ratio and, as a result, the metric isn’t as “meaningful” when it comes to assessing the market. The crash in 1989 was also precipitated by the Bank of Canada’s decision to rapidly raise interest rates. “It seemed as if Bank of Canada policy was solely aimed at bringing the Toronto housing market into control,” Porter says. This time around, the central bank has made clear it has no intention of doing so again. The provincial government (along with the federal government before it) has instead implemented policy changes to cool the market. Porter, who believes Toronto real estate is definitely in a bubble, anticipates the market will follow a similar trajectory as Vancouver, with sales dropping but prices not moving much in either direction.
In way, that too is a “this time is different” argument: today’s policymakers, having learned from the crash of 1989, can confidently use policy changes to manage a soft landing for real estate. In the end, though, markets are driven in large part by psychology. History shows we have a tendency to jump on trends, drive asset prices higher, and bail when trouble arises. Until human nature changes, perhaps nothing will be all that different.