What Fuels a Real Estate Bubble??

Last post, I discussed the single most important factor that initiates a real estate bubble: deregulation that results in easy credit.  Today, I will discuss three factors that fuel a real estate bubble and discuss how this has affected the American real estate bubble.

Population influx

New job prospects represent the main reason people move into a new area.  Population influx to a city drives the demand for housing higher and therefore, has a positive increase on housing prices.   Near the beginning of the Greater Vancouver real estate boom (circa 2001), the population sat around 2.0 million people.  By the end of 2011, the population had increased to over 2.4 million, or a 20% increase over ten years.  However, since many of the jobs created are in the construction and housing related industries (construction workers, real estate agents, lawyers, home inspectors, plumbers, etc.), any slump in this sector will have a profound effect on the economy, job market, and ultimately real estate prices.  Approximately 40% of the Greater Vancouver economy is real estate related and history has shown, when a city relies too heavily on any one industry, especially the real estate industry, dramatic price reductions can occur in an economic slowdown. 

States like Nevada, Arizona, and Florida also had a massive influx of people in the last 20 years.  At it’s peak, Phoenix experienced a massive population boom during their real estate mania.  Population was increasing approximately 4% to 5% per year between 1995 to 2005 (about twice as fast as the Greater Vancouver) and fuelled one of the largest real estate bubbles ever.  However, similar to the Vancouver real estate bubble, many of the jobs were related to construction field.  When the economy started slowing down, it has a catastrophic effect on housing prices.  Some areas of Phoenix plummeted by 70%. 

Assumption that houses are always a good investment

How many times have you heard somebody say “Well, they ain’t making any more land,” “It’s different here,” or “Real estate only goes up” when describing the Greater Vancouver real estate market??  Real estate, just like any other financial asset and can experience price fluctuations.  After all, it is a commodity, like oil, corn, or cars and as such, are subject to the laws of supply vs demand. 

What is interesting to note is that many Americans view real estate as a very risky asset while Canadians view it as a safe and insulated investment class.  However, had you asked any American south of the border the question in ’06 or ’07, they would have told you that it was the best investment they ever made.  This is where Canadians sit now. 

Americans hate real estate. 

Canadians love it.  For now.

Warren Buffet once said a important rule for investing:

“Be fearful when others are greedy and be greedy when others are fearful” 

Here is, what I think, a fabulous graph showing the business and real estate cycle.  Where do you think Americans sit on the graph??  What about Vancouverites and Torontonians??  

Here is another graph that shows the business and real estate cycle but shows the emotions of a investor or owner.  If you are a Canadian, look at the graph and think of your family and friends that have bought a house in the last ten years.  Where do you think they sit on the line??  Are they at risk?? 

Remember, no real estate bubble never lasts forever.  If you are thinking of buying a place, where on the graph do you think is the riskiest place to buy??

“You never want to be a sheepish investor… always get out before the herd does”  

For the record, I just made that up.  Basically, it means don’t be caught holding the bag.

Media promotion and real estate obsession

real estate stock

During the last 10 years, television has been used by the real estate firms to promote the real estate bubbles.  Have you seen HGTV (Home and Garden Television), a channel solely dedicated to the pumping of the Canadian and American real estate.  Shows like “Property Virgins”, “House Hunters”, “Selling LA” and “Income Property” promote delusional real estate buying by so called investors and property virgins. 

Many young property virgins watch these shows and with no down payment, expect to get a house with stainless steel appliances and granite countertops.  Most haven’t a clue how to calculate how a mortgage works and what amortization means.  On an episode of “Property Brothers,” I was watching yesterday, I saw a couple making an offer on a place in downtown Toronto.  They were told that the place was $650,000 but there were four other buyers and to put their best offer first.  The property virgins ended up paying $45,000 over the asking price since they had to have their dream house as their first place.   

Many Americans can attest to the home ownership obsession that gripped their nation.  However, Canadians are no different, we just are doing it a little later.

But, something tells me Canadians really aren’t going to end up to any different than the Americans.  Only time will tell.