Updated: Sep 8
Real estate is a strong inflation hedge.
That’s a general perception. But is it really true?
Is there any data to back that up?
The latest prediction from Oxford Economics says that the Canadian housing market is going to see prices plummet 24% within the next 2 years.
It even says the crash could be as much as 40%.
How likely is that going to happen?
Today, I’m going to show you some data correlation that you have never seen before.
This kind of data isn’t readily available anywhere.
Our team actually went into the monthly market watch report for the past 22 years, one by one, to extract the relevant data and present them to you in meaningful graphs.
Data is king and history tells us about the future, right?
At the end of this video, you will have the data to make an educated decision for yourself.
Let’s start with the Consumer Price Index.
It measures the average change in prices over time that consumers pay for a basket of goods and services.
Here’s the graph of the CPI from January 2000 to February 2022.
As time goes by, prices for things gradually go up.
No surprise here. We always see things get more and more expensive. We never really see things get cheaper over time, right?
Let’s take a look at the House Price Index in the Greater Toronto Area.
It’s similar to the Consumer Price Index, but it only measures home prices in the GTA.
Like I always say, home prices can go up and down in the short term, but the long term trend is always up.
In fact, it’s going up at a much faster rate than the CPI, see that huge gap at the end of the graph.
So the takeaway from this graph is that prices for things always increase in the long run and that home prices in the GTA are increasing faster than everything else.
Now, let’s take a look at this data in a different way.
If we take the Consumer Price Index and calculate the year over year percentage change, that number is the inflation rate.
The inflation rate went negative twice in the past 22 years.
The first time was during the Financial Crisis in 2009.
The second time was of course Covid in 2020.
And we just saw a 30-year high inflation rate of 5.7% in February.
Now, let’s take the Home Price Index and calculate the year over year percentage change and put that on top of the inflation curve.
See how the 2 curves have very similar shapes.
This tells you that Toronto home prices do hedge inflation.
In fact, they beat inflation.
For example, from year 2000 to 2006, the percentage change in home prices was generally double that of inflation.
You see, if you make the right investment, you can actually profit from an inflationary environment.
Some odd things are happening though.
There were 2 big peaks in the graphs.
In April 2010, home prices were up 17.1% year over year.
In June 2017, home prices were up 29.3% year over year.
So what happened during those times?
In 2009, the Financial Crisis brought us into a recession, inflation went negative and home prices dropped 7.6%.
Our government launched Canada’s Economic Action Plan, which injected $62 billion into the economy and helped 420,000 Canadians get back to work.
The economic recovery was relatively quick.
Inflation was back up at around 2% early 2010.
Home prices jumped 17.1% as people had more money to spend and interest rate was almost at 0%.
The curve came back down at the end of 2010.
Keep in mind that this curve plots the percentage change in home prices.
So with the curve coming down, it does not mean a price drop.
It’s telling us that home prices increased 17.1% year over year in April 2010 and it only increased 4.2% in December 2010.
It’s when the curve goes below 0%, then that’s a year over year price decline.
You see, price declines really only happened twice in the past 22 years.
During the Financial Crisis in 2009 and in 2018.
You probably still remember that 2017 was a very crazy year in Toronto real estate when prices jumped almost 30% year over year.
Then very quickly, the bubble burst in 2018.
So what happened?
What’s the cause of that dramatic inverted-V in the graph?
Inflation was pretty steady at around 1 to 2% during that time.
So that’s not the reason.
Remember we discussed the market absorption rate a couple weeks ago.
If we take the number of Active Listings, meaning the number of unsold units at the end of the month, and divide that by the number of sales in the month, then we get the market absorption rate.
When the absorption rate is bigger than 1, that means there’s enough supply to satisfy demand.
The bigger the number, the more supply is available.
If the absorption rate drops below 1, that means supply is not enough to satisfy all the demand.
Let’s take a look from year 2000 to 2008.
The absorption rate hovers around 2 to 4, so there’s plenty of supply.
Home price increases tracked the shape of inflation, doubling the rate of return of inflation.
See what happened just before the price decline in 2009?
The market was flooded with supply because everyone was worried about the financial crisis.
And as we know, when there’s more supply than demand, prices drop.
We had a quick economic recovery from the recession and Toronto’s population continued to grow.
Supply started to get tighter compared to the years before 2009.
And so prices continued to rise.
Look what happened in 2016?
The absorption rate dropped to just around 1 and to only 0.65 in April 2017.
Supply was not enough to catch up with the population growth.
And as a result, prices suddenly skyrocketed.
The government reacted immediately by imposing a 15% foreign buyer tax in hopes of curbing soaring prices.
The market crashed shortly after.
It’s more of a psychological crash though because whenever a new policy is introduced, people are naturally worried.
When you look at the absorption rate, it rose from the bottom but still remained at a very healthy level.
It’s not like the market was flooded with supply.
Indeed, the psychological crash was just temporary because this market was driven by real demands.
And as you can see, when the absorption rate dropped between 2019 and 2020, prices started to increase at a steeper rate.
When Covid hit, the absorption rate spiked for a little bit.
At that time, there were very few buyers in the market, but no one was panic selling either, so the market was pretty much just frozen.
Then we all know what happened.
Prices kept going up with 15 to 20% year to year increases.
Notice how the absorption rate graph has been dropping?
It dropped below 1 again and was only at 0.77 in February 2022.
Our supply has never been so tight for the past 22 years.
And don’t forget that 30 year high inflation.
I don’t know how the market can crash 40% under these conditions.
Unless a substantial number of housing units is magically built to increase supply…
Or somehow people stop coming to Toronto and demand drops dramatically…
Any government policy attempting to curb real demand would only have a temporary effect because it’s not fixing the root of the problem.
Until we see the yellow curve skyrocket and stay at a high level for months, I don’t think there’s much room for housing prices to come down.
Here’s the thing.
You could hate inflation and complain about it.
On the other hand, you could profit from inflation if you made the right investment.
The choice is all yours.
Comment below and let me know what you think.
If you find this video valuable, share it with your friends.
Subscribe and hit the bell so you keep getting more and more valuable content.