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In came the waves

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The worldwide rise in house prices is the biggest bubble in history. Prepare for the economic pain when it pops

So begins the Economist’s landmark article on the global RE bubble from June 2005. It’s now available for free viewing after years behind the pay wall.

This is the classic analysis of the housing bubble IMHO and the one that made me bearish on RE. Its arguments are my arguments.

“The most compelling evidence that home prices are over-valued in many countries is the diverging relationship between house prices and rents. The ratio of prices to rents is a sort of price/earnings ratio for the housing market. Just as the price of a share should equal the discounted present value of future dividends, so the price of a house should reflect the future benefits of ownership, either as rental income for an investor or the rent saved by an owner-occupier.”

And there you have it. It’s possible to ascertain whether housing is over-valued because it’s an investment, whether or not its owners think of it as one, or what they mean by an “investment” in the first place. Eventually market forces and marginal pricing must prevail and that means that prices must fall back to a level justified by rental value.

Do read the article if you haven’t already, and try adding Vancouver (or other major Canadian markets, or just the Canadian average) to the graphs. How do we look compared to the US and other countries in 2005?

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Anonymous
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why not just dig out what vhb and other bears posted since?

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6 years 10 months ago
chip
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We stopped buying shortly after that time because of these same arguments. I think it was the logical decision to make.

But reason can lose you money. For example, we owned a flat in London, bought at 176,000 pounds. Today it's worth 260,000. We owned a two storey condo with roof terrace in Toronto, bought for $310,000. Today they are selling for $580,000. A third place here if held onto would have paid for all of my kids' educations.

So, while my logic was impeccable, and I was looking pretty sharp in 2008, it has cost me.

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6 years 10 months ago
Ziggy Strawdust
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@chip: No. Not buying a lotto ticket for a million dollar lotto doesn't mean you've lost a million dollars, it means you didn't play the game.

Taking on a $500k mortgage for a $300k house means you've lost money.

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6 years 10 months ago
patriotz
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@chip:

Not buying never costs you. What costs you is buying at an excessive price and not selling later at an even more excessive price. Whether you're able to sell at that price or not.

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6 years 10 months ago
vanpire
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@chip:

A third place here if held onto would have paid for all of my kids’ educations.

My kids are paying for their own education. Perhaps this is why they're doing great in college – makes them appreciate it just a little bit more.

But I digress…

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6 years 10 months ago
Calgary Real Estate
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I think home prices depend a lot on local economy. Home prices in most USA cities have tumbled while prices in most cities in Canada have stayed stable.

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6 years 10 months ago
Christie
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@vanpire. Not paying for your children's post secondary these days is just irresponsible parenting. However you want to spin it.. they are doing great in college etc, is just some way to help you sleep at night. We already know our kids won't be homeowners, why not help them have what we had in at least some aspect of their lives?

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6 years 10 months ago
Dave
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@patriotz:

That's silly logic and history shows that to be incorrect.

You could never buy using that logic, short of a Phoenix or Las Vegas style crash. If you used that logic in 2000 (the start of the bull market), you would sat on the sidelines. It was still cheaper to rent back then and buying a condo or house required higher monthly payments. In the short term, rent wins out. In the long term, you build equity and your asset appreciates, while rent keeps going up.

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6 years 10 months ago
Dave
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@Christie:

I think there is a balance between the two. I have seen many people not value their education or take it seriously because mom and dad paid the bill. I have also seen many people have to work excessive hours during University which reduces their focus on education and often prolongs it.

I think a little bit of help from family is OK, but it should be conditional on the kids having to work during the breaks as well.

I don't think coming out of University with a lot of debt is a good thing.

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6 years 10 months ago
Junius
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#6 Calgary Real Estate,

You said, "I think home prices depend a lot on local economy. Home prices in most USA cities have tumbled while prices in most cities in Canada have stayed stable."

Yes, local economic factors matter. However housing prices have been rising for years while real income levels have remained stagnant. Home prices have risen because of access to cheap credit and not because of improved economic conditions. It is more relevant to look at historical relationships between home prices, rents and income. When you do that it is clear that prices in most Canadian cities are way beyond historical levels and are set for a fall.

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6 years 10 months ago
patriotz
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@Dave:

That is complete nonsense. Someone in the US who didn't buy in the early 2000's because renting was cheaper is way ahead of someone who bought. The guy who bought would be able to sell the house for about what he paid for it, but he's paid more out of pocket every year.

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6 years 10 months ago
N
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@Calgary Real Estate:

"I think home prices depend a lot on local economy. Home prices in most USA cities have tumbled while prices in most cities in Canada have stayed stable."

Actually home prices in most Canadian cities have gone up a lot, even though the local economies in these cities (things like average incomes) have not been anywhere near as strong as those in US cities where prices have fallen. Compare, if you will the economy of Japan to the economy of Canada. Which one is stronger in absolute terms? Which one has the higher unemployment rate? And how has Japanese real estate done?

The thing about bubbles is that prices become detached from fundamentals on the way up, and on the way down the momentum is so great that it outweighs any other consideration in the local economy.

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6 years 10 months ago
patriotz
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@Calgary Real Estate:

I guess you missed the irony that Calgary RE has dropped over 10% since 2007 yet oil prices are far higher today.

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6 years 10 months ago
pricedoutfornow
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Just stumbled upon this gem in (of all places) Ben Jones' blog. It's hilarious! You could probably have had this same conversation in 2005 in California. Americans must think we're idiots! (I know they do).

http://www.bclocalnews.com/greater_vancouver/neww…

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6 years 10 months ago
DaMann
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@Christie: "Not paying for your children’s post secondary these days is just irresponsible parenting" Are you for flippin' real or is this a wind up? If you got lot's of spare cash and want to pay for your kids education then go for it but to strap yourself down financially just do so is irresponsible. What ever happened to letting your kids earn their way through life? At least to start out. A lot of these kids in school have no clue about anything, especially money. Handing them cash so they can go party in Uni is stupid. You sound like someone who has had a lot of things handed to them from Mom and Dad hence the "kids are entitled" to have cash handed to them for education and houses. There are too many handouts going around. Make the… Read more »
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6 years 10 months ago
900kCrackHouse
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Sell your crack house and buy gold. It increases at a faster pace than Vancouver real estate and is still a good deal compared to your house.

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6 years 10 months ago
WFT?
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@Dave:

What? A real estate bull thinks there is something wrong with debt? Or is it just any debt that gets on the way of taking on more real estate debt?

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6 years 10 months ago
900kCrackHouse
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@Christie: If they are living at home, motivated students can usually pay for their education completely using scholarships and good summer jobs. Having mommy and daddy cover the cost of everything teaches the wrong lessons. I would argue that students that are able to cover the cost of their own education probably will be far more successful in life. With that said, obviously its best if the parents are in the background covering off some of the costs (20% if living at home and 40% if going away to a good school).

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6 years 10 months ago
900kCrackHouse
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@Christie: Is this Christie Clark?

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6 years 10 months ago
Dave
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@WFT?:

Exactly. How can we expect first time buyers to save for a downpayment when they have to service all their student loan debt?

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6 years 10 months ago
Not much of a name...
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@Dave: Simple. Get a better degree than a BA in psychology.

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6 years 10 months ago
DaMann
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@Dave:

Or maybe they shouldn't be home owners until they have paid off their student loans? Wow there's a thought!

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6 years 10 months ago
Dave
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@DaMann:

Sure. Nothing wrong with that.

I am just saying that starting your career with high debt limits your ability to buy real estate. With the high price of housing, it isn't feasible for the average person to just start out and buy a house. Rather, the current reality is that people have to work their way up the market and the earlier they can start, the better.

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6 years 10 months ago
whydoItry
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I would rather have had an analysis that showed the median monthly mortgage payment versus the rent for a similar property. Or even how the percentage of income to service the mortgage payment has been changing would have been a good one too. Or how the length of time to pay off the mortgage debt has been rising. Or how the default rates are increasing. The problem with comparing the rental market to the housing market is that it has the same validity as comparing the condominium market to the detached house market.

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6 years 10 months ago
WFT?
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@Dave:

Maybe they shouldn't go to school at all. You can make multiples more money as a re agent. Why spend 5 years on university to become a teacher starting at 36k per year. Even phd is worth little compared to a re license.

Even my doctor makes less than the re agents I know. Why would any one spend 10 years training to be a family doctor?

The cost of education far outweighs the reward.

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6 years 10 months ago