Bubble burst or Correction?

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Market change is a bubble burst or correction?

For years we heard that Toronto’s housing market was a bubble. Recent Rapid interest rates increases have slowed down the real estate transactions volume and have reduced the housing prices in 2022. How can we perceive this market change? Is it a bubble bust that some people have been saying  for years and some got short positions to benefit from free fall real estate market? or Is it a market correction that occurs in any market naturally?

To answer these questions, it is better we look into the core real estate factors influencing the housing market and prices. Like any other market, real estate is under supply and demand rule. When the supply and demand imbalances due to whatever reason we will see housing prices increase or decrease depending on which one’s transition is stronger. We intend to assess the current real estate market disrupters including the increasing interest rate to better understand the market dynamic and possibly conclude if there is just the beginning a bubble burst or the market is correcting itself.

Housing shortage - It was not long ago that analysts highlighted that Canada had not invested enough in generating new houses and it suffered from a housing shortage. There were some blames towards policy makers that were not leading the market and developers to generate enough houses resulted in housing supply in the market.

Population increase - Canada’s population as per consensus 2016 was around 35.1 million people. The population increased to an estimated 38.9 million people in July 2022 according to the Statistics Canada. This 10.8% population increase in about 6 years suggests there is a strong demand for housing in Canada in general regardless of demographic changes. Increasing immigration plans issued by the government demonstrates population increase uptrend will remain, which it supports the demand for the housing in a long run. 

Investment - There are foreign investors who take advantage of free market to invest in hot real estate zones such as Toronto. There are macro economic factors such as exchange rates contribute to the decision of a savvy international investor to invest in a political stable state like Canada. There are some investments, however, aimed for immigration purposes for future that allow wealthy people plan for their living in Canada. No matter what type of levies local municipalities set for the foreign investors, some of them find their own way to buy properties under their kids who will graduate and become residents or possibly under their close relatives names who have residency status in Canada.

Inflation - High inflation after COVID 19 has raised building materials cost and labour wages to build a house. The inflation is closely monitored by the Bank of Canada, as it has already increased the interest rate multiple times to tame the inflation. It appears this action takes some time to lower the inflation. High material costs and labour correlate adversely with housing supply. Additionally, the higher cost of the houses do not contribute to lower housing prices as a seller would probably pay more for his/her house to buy a similar one.

Interest rate - It is correlated with housing affordability preventing families to change their houses, developers to invest in a new project and new home buyers not to be qualified for a mortgage regardless of the house price as their affordability has been diminished by the higher cost of borrowing. The general notion is real estate prices are coming down, so let’s wait until for the rock bottom of the market, which one must have a crystal ball to determine the bottom of the market presumably that person is qualified for a more expensive mortgage. 

As expected the real estate market has been impacted by the interest rates increases. However, increasing rate is not the only underlying factor to housing prices and affordability. It appears increasing rate is a patched lower real estate era that would not be sustainable for a long run. The market has been transitioned to a high interest rate and it is adjusting itself. Other economical parameters are changing and we will see the increased rate impact on the overall economy in the next few months. Whether SME’s can afford to retain their employees or finance their projects, they will be under tremendous economical pressure as their financing costs have been increased. They would not pursue their expansion plans, preferably to wait for market changes that is not necessarily support the employment rate. 

Overall, we experienced that the lower interest rate did not last for ever. The higher interest rate would change. It all depends to the markets adjustments. As other real estate market factors discussed above are positively influence the housing market, the high interest rate has dominated the market for now. That said, higher interest rate cannot generate more houses while the population is increasing. Therefore, this market swing cannot be a free fall. It is more of a market correction in our view.