How to Forecast a Drop or Price Correction in Real Estate

08 June 2011

Before we get to the ‘how’, we are always surprised at ‘why’ so many people keep calling for a price correction for the real estate market. Most forecasters know that calling for more of the same – stable to rising markets does not sell newspapers, books, and speaking engagements. All the press goes to those who forecast the end of the world. And if a forecaster is ever right then they can get elevated to even greater status. And if they are wrong? They can bring out their dire forecast the next year and the next, until they are right. The worst is Garth Turner. He has been forecasting the demise of real estate and condos in particular since 2003. If you took his advice and sold, you would have lost 50-60% minimum in value. And Garth was only talking about a 10-15% correction. So who is right?? We could beat a dead horse all day about the errors made by forecasters. But there are really only two indicators you need to watch. First are interest rates. No, it is not increasing rates that will signal a market correction but the SPEED of the increases. Man is very adaptable. If you tell him mortgage rates will increase from 3 to 6% in three years he will adjust. If the increase takes place in 6 months, then there will be problems. Just look at the Australian market. There mortgage rates are 7%+ and they have higher real estate prices than in Toronto! How is that? Australians have adjusted. We can remember when interest rates were 9% and more in Canada and the market was excellent. What killed the market were not 14% mortgages but the fact that it went from14% to 22 % in less than a year!! The second indicator is the percentage of owners in ‘mortgage arrears’. In a normal market, prices do not adjust downwards when there is excess supply (more listings than buyers). What happens is that owners do not reduce their price; they just take their property off the market. The only owners who will sell with falling prices are those who have to sell – they are people who are in arrears in their mortgage payments. They either sell or lose their house to the bank. That is the U.S. scenario. In Canada we do not have that problem. Mortgage arrears are at .4% of mortgages outstanding. The low over the past 20 years has been .3% and the high (reached at the ’89-91) real estate correction was .7%. Compare that to the U.S. which is 20 times worse at 7% today!! So where do we stand today? The Bank of Canada would like to raise its rate by ¼% in the fall – big deal. Interest rates are not going to rise by 1% within the next year! Mortgage arrears are near historical lows and 49% of Canadians in a recent survey by the Canadian Association of Accredited Mortgage Professionals voluntarily increased their mortgage payments over the year. Hardly a sign that owners are struggling. In summary, the indicators are there for NO market correction or drop in real estate and condo prices for at least the next year! And you can take that to the bank!