In our last post, we learned that in
addition to people consuming many lines of cocaine while listening to Another Day in Paradise by Phil Collins,
people in Toronto assumed that real-estate prices could only go up. There was a fear that if one did not buy now,
she would be priced out forever. Plus, everyone was worried about some
foreigner buying up any remaining properties left for "true
Canadians". Mortgages that consumed
most of couples' incomes, wages that were barely moving, well, most people
thought it would somehow balance itself out just like a federal budget.
Truth be told, balance was eventually
found.
The Toronto housing market peaked in
late 1989 and began a painful seven year contraction. Prices reverted to, drum
roll please, back to the long term moving average and underlying fundamentals.
In addition to the misery of falling prices, a recession hit in the early 90's
which compounded the economic situation.
There were some defaults, but thankfully not a complete melt down like
we have witnessed in various locals around in the world in the last 10 years. It
can best be described as an orderly correction.
Where did all the buyers go? What
happened to all those rich people from Hong Kong everyone was complaining about?
I thought we ran out of land long time ago? Isn't Toronto the new
"Manhattan" that can't possibly decrease in value?
Hmmm...
Maybe once average people couldn't buy
average places, they would just stop buying? Maybe the foreign investors played
a smaller role than we thought? Maybe the land in Toronto has stayed pretty
much the same since the last ice age? Maybe Toronto isn't the new
"Manhatten?" Maybe people
became completely fixated on real-estate to the point where they were
delusional?
All excellent rhetorical questions that
I do not have the answer to. They say
hindsight is 20/20; however, we can deduce the following from the available
information:
1.
Prices
increased several times the long term moving average over 5 years
2.
Incomes
did not keep pace with the large increases in home prices
3.
There
was a surge of listings and simply not enough buyers
4.
Interest
rates increased
5.
Lenders
were too quick to provide financing to people who were not creditworthy
6.
Many
people borrowed too much money
7.
The
masses saw a get-rich scheme by buying and flipping properties
8.
When
prices stopped increasing, back alley lenders left the market under the cover
of the night eliminating a large pool of money to keep the pyramid going
9.
Psychological
factors like greed and fear played a role in people's irrational decisions
It's likely that a combination of the
above factors played a role. We know from previous speculative manias that
psychological factors play a driving role as once the masses become fixated on
something, people begin to act irrationally to the point of
self-destruction. As mentioned in the
previous posts, no one can predict when or how it will happen, but the house of
cards will eventually collapse under its own weight one way or another whether
we like it or not.
For those persons who bought at the peak
of the market - more misery. There is a common belief that even with the dip in
prices, people still made their money back a short time later. But when? 3
years? 5 years? 10 years?
Let's take a look at an inflation
adjusted graph (in 2012 dollars) of how long it really took for those
homeowners who bought at the top just to break
even.
It took a full 21 years for prices just to recover. Enough time to get married,
have a few kids and send them off to university. About 28% of Canadians move every 5 years
meaning that a large chunk of people who bought at the peak ended up
crystallizing their housing loss. Some
sellers were even forced to borrow additional monies to pay back their lending
institution(s) after selling because the existing mortgage(s) was more than what the sold the house for. It was as if the seller was paying the buyer
to take over their house. Remember folks, you cannot write off your personal housing
loss as a tax loss. Talk about a scary situation!
If we had a time machine and could back
to 1989, we would first have to see a Michael Jackson concert. No question
about that. After the moonwalk, we would
interview a few random people on the streets of Toronto. I'm willing to wager that if you were to ask
any Torontonian if house prices would go down, you'd get a resounding
"no". If I was not a toddler
at the time but rather some young, handsome downtown living professional with
his own fax machine, I'd probably say the same thing.
They would tell you that prices can only
go up, there is no more land, immigrants are flocking to the city in record
numbers, Toronto is a world class city and the foreign investors would continue
buying property. If you were to tell
them that house prices will not only drop for 7 years straight, but take 21
years to reach the breakeven point again, I'm confident you would have been
laughed at and called a raving lunatic.
Which begs the question: did the city
just stop growing for 7 years? Suffice
to say, the GTA population increased just under a million people from 1989 to
1996. Immigrants continued to come to our great city. And, no, they were not
sleeping in tents outside city hall. Yet
prices continued to slide.
But what happened to mortgage
rates? The average 5 year mortgage
interest rate went from about 14% in 1990 to 7% in 1993. That is a massive 7% reduction in just three
years. Yet prices continued to slide. [Brain twist, what would happen if your
mortgage rate were to increase 7% the next time you had to renew your
mortgage?]
The
GTA population increased by big numbers, immigrants kept coming to the city,
mortgage rates decreased dramatically,
no new land was magically formed in Toronto outside that which was left over
from the last ice age and prices declined year after year after year until it
reached its underlying fundamentals. Sanity and rational thinking returned to
the market.
Mortgages from sketchy back alley
lenders disappeared. Bidding wars turned into sellers offering back rubs and
expensive brandy to prospective buyers who actually came to a showing. Real-estate investors returned to being
investors rather than acting as speculators. And above all, average people
could again buy average houses.
When it became clear that the top of the
mania was reached and prices began their inevitable decline back to the long
term fundamentals many were still in denial.
Warren Potter wrote an interesting piece in The Toronto Star on July 21,
1990, titled Don't we ever learn from
past?
"It's a wacky, wacky, wacky
real-estate world all right. But do you know what concerns me? We'll eventually
lift ourselves out of the doldrums and, in another four or five years time,
we'll be off on another boom as this roller-coaster industry once again reaches
a summit.
Today's woes will be forgotten...until
we hit another low.
Then people will react with the same
shocked surprise that has permeated through today's real-estate market.
Don't we ever listen, read or
learn?"
Do we listen, read and learn from the
past? Or are we bound to repeat the same mistakes again, again and again? I
leave that to you to decide.
