Error in Simplifying House Market Forecasts

07 September 2011

This week the Globe and Mail published another article from Capital Economics saying that the House Market was bound to collapse with house prices falling by 25%. I feel sorry for people who have to read this overly simplistic view and hope that they do not follow Mr. Madani’s advice and run for the hills. What Mr. Madani has done is to plot house prices versus income per capita over 25 years for Canada. We have previously criticized the one market theory for Canada. Real estate is very regional. When you look at the U.S. , prices are still decreasing in some parts of the country yet, they are rising in others like Manhattan. But what is really disappointing for an economist is that the simplicity of the graph assumes that housing affordability and hence prices do not change over time. For most of the period, interest rates were 9% and higher. Today they are at 3%. Of course people can now afford and buy a more expensive house. The only justification must be that Mr. Madani believes 9% mortgages are just around the corner. When do you want to bet that it will happen? The second problem is that income per capita is based on Statistics Canada data. Twenty five years ago, the underground economy was very small. Today you tell me what the number is? My guess is 20% and that never appears in the stats. In conclusion, I am not naive enough to believe that prices will rise indefinitely. I do know that our prices will level off and perhaps decline by a small amount at some time in the future. People who want to wait for a 25% correction can probably rent in the Toronto market for at least the next ten years; and perhaps forever!!