Can Real Estate and Condo Prices Really Fall by 20%

07 April 2010

Just read the article in the Saturday Star where an economist predicted that prices could fall by up to 20% later this year. I am embarrassed to admit that I am also an economist by training but a Realtor by profession. It goes to show you how little economists really understand about the real estate market. Economist all rely on 'demand and supply' and the 'law of substition' to explain most economic markets. Unfortunately residential real estate does not work that way. Let's start with demand and supply. Sure more listings are coming on the market and if supply exceeds demand prices usually fall. But not so in residential real estate. People need a place to live and in my 30 years in the business, if sellers don't get their price, they just take their property off the market. The only time you have falling prices is when there are forced sales such as foreclosures and power of sales whereby lenders are in control. That is what happened in several states in the U.S. Talking about mortgage arrears, it is currently at .3%. Back in the early nineties it peaked in Canada at .6%. In comparison the U.S. rate is 20 times higher. That's right TWENTY times. So it is unlikely that we will approach those numbers in Canada. Sitting on the fortieth floor looking out this economist notes that interest rates are rising. Unfortunately he needs to be on street level to appreciate what most buyers are doing. Most first time buyers have been locking in the five year rate for the past two years. My observations with actual buyers is that they are being cautious when it comes to qualifying for mortgages and banks have been building in a cushion too over the last few years. Finally we need to address the law of substition which says that if a product is too expensive, you just look for a cheaper alternative. The problem is that housing is not interchangeable - who can move from a 4 bedroom house with kids to a studio condo because it is cheaper? Also an excess supply of housing in one area is very difficult to move to an area with a shortage - the last time I looked real estate had not grown any legs! So let's just summarize the debate in a less than sensational fashion. With higher interest rates and the HST coming, we do expect a slowing in this hectic market. In fact the signs have already appeared. With more listings, prices will level off this fall. There will be no panic selling and hence forecasting any significant price drops makes no economic sense (there's that word again).