Real estate values in general do not follow the basic laws of supply and demand as do mainstream purchases such as cars, shoes, or computers. Of course, people can be sensible – dispassionate about utilitarian goods, but not about investments like stocks, bonds, or real estate.
Some of what follows can be attributed to Robert Prechter and his theories of the wave principle. Thus, for instance, if a well-known retailer discounts by 30 per cent a 50-inch high-definition television set, one forthwith purchases that item. However, if one were to drive by a house that one is contemplating buying and notes that the price has dropped by a big percentage, the immediate reaction is, "What’s wrong?" rather than, "I’ll buy it." Obviously then, some purchases are determined by factors other than need.
Robert Sniller, a Yale University economics professor, has created what he calls the National Home Price Index, adjusted for inflation and uses 1890 as the benchmark year (in the United States). That index reveals that up until 1997, real homes values, that is adjusted for inflation, had not changed by very much in more than 100 years. Since then, as most of us recognize, there has been an exponential rise in real home values. Anecdotal evidence abounds of house prices that have soared in recent years, and recently in Toronto, a house was sold for 50 per cent above the asking price.
Simply based on supply and demand, that cannot be explained. Baby boomers gradually are moving to smaller homes, and raw population figures show that the rate of population increases has diminished.
Mortgage rates remain at absurdly low levels, and there are mortgages being granted at 125 per cent of appraised value to borrowers who have "no income, no job, and no assets," so-called "Ninja mortgages."
Despite those lax conditions, house prices in Canada have started to slip, mirroring a sharper decline south of the border. In both countries inventories of unsold houses awaiting purchasers have risen dramatically. What has triggered that dramatic reversal in the real estate market?
Certainly, it is in part a response to the fundamentals cited above. Perhaps of even greater importance is an unconscious, seemingly spontaneous herding behaviour. Whether or not it is tulip bulbs, high-tech stocks, or nowadays, real estate, herd-like trends occur, swamping logic and basic principles. Waves of irrational crowd behaviour overwhelm common sense.
Despite the fact that builders, bankers, and brokers all want higher real estate prices, a major corrective phase is underway, one that could erase most of the price advances of the past two decades.
