Recently I was invited by the Canada Mortgage and Housing Corporation (CMHC) to speak at their Housing Finance Symposium. I usually turn down interview requests, panels, and public speaking opportunities. However, this was a technical talk for banksters, and policy makers on the Future of House Prices. I was one of two Canadians invited to speak on the topic, so I took the opportunity. I figured I would do a technical talk on forecasting speculative markets, and how to use forecasting to detect BS.

The talk went well, but it was the only one over two days where I heard people audibly gasp during a presentation. Quite a few analysts and bank executives that attended (or heard what I said from friends), have since requested my slides and meetings to ask questions. Rather than respond to every email, I figured I would assemble this into a more in depth series of articles for our readers. Since you know, I only entered the housing industry to democratize housing information – not have closed door meetings. My primary belief is when markets are less opaque, they become much more stable.

Note: The following is based on the presentation made, but has been reorganized slightly. This allows us to go more in depth on certain topics, as well as break it up so it’s not too long of a read. This is part one, which summarizes the absurdity of current expectations.

First, A Little About Me

Save a few Twitter rants, I’m a little reclusive – so this where I’m coming from. My background is in artificial intelligence, machine learning, and equities analysis. Basically, I used to build robots that analyze the stock market, then make intelligent trade decisions. Yes, the kind used by high-tech trading firms, and individuals with supervillain amounts of money.

I’m the co-founder of Better Dwelling, a media company that applies these same technologies to real estate data. Our goal is to democratize analysis, and data that is typically reserved for deep pocketed investors, and put it in the hands of Millennials and policy makers, so they understand the market. 90% of the top 100 banks by AUM, have at least one executive that reads us, at least once a week. We’re just over a year old, so if you’re not a bankster you may not be a regular reader. However, we play a significant role in how the experts you do listen to see the market.

Money 101, and Support Levels

First, we need a brief introduction to a very basic money concept that’s little known outside of equities market – support levels. When commodities make an unprecedented rise, traders look for when buyers will establish support. That sounds a little technical, but basically all they’re looking for the lowest price that would trigger buying. This isn’t based on fundamental performance, it’s based on buyer psychology. Buyers and sellers leave marks on a chart, that are very often very clear to traders that understand technical analysis.

This may sound like they’re reading tea leaves, but it’s surprisingly standard. In currency and equity markets, ~23% and ~38% are popular levels to observe this response. That’s pending no additional downward pressure, like fraud or bankruptcy. It’s so popular, most private trade algorithms have it pre-programmed in as “catches.”

We’ve been applying machine learning to determine if this concept applies to real estate, and we’re finding significant correlations. Many North American real estate markets tend to establish a support level in the home price to income ratio, between 28-30% lower than an unprecedented peak. Pending your city doesn’t turn into Detroit, and has a devastating loss to its underlying economic foundation.

Why is this important? In modern real estate markets, the ratio rarely resets. They continue to rise, but with retracement around these levels. Basically, people become more comfortable devoting a higher level of income to shelter. People were wondering where that level is, and 28-30% lower is what we’re finding.

House Price To Income Ratio

The second thing you’ll need a brief understanding of, is the home price to income ratio. A home price to income ratio is a common indicator used by governments and academics. The ratio tells us how quickly home prices are growing (or shrinking) compared to incomes. There’s a few variants, but we like to use the price of a typical home, compared to the median income.

When the ratio goes down, it means incomes are growing faster than home prices are rising. When it goes up, it means home prices are growing faster than incomes. There’s a little more to it, but those are the basics.

Home Prices Will Be Flat … Is Bulls**t

One of the most common things I hear after a home prices surge, is prices will be flat until incomes catch up. It’s a common explanation, I hear from some very credible people. Most people give it a thought, then just accept that statement. If you’re a money or data person however, this is what you picture.

Adjusted to 2015 Dollars, for your inflation adjusted pleasure. Source: TREB, Better Dwelling.

You don’t have to be a data expert to understand there’s something wrong with this chart. If I saw it, I would assume there was a plotting error. However, this is how a lot of high profile experts actually explain real estate markets.

In fact, one of the people I recently heard this from is one of Toronto’s largest private wealth managers. He’s currently advising ultra-high net-worth (UHNW) clients, which are those with more than $30 million in investable assets, to continue to buy real estate. He believes home prices will be flat until income catches up, and then prices will continue to climb. He’s a credible guy, and he’s right more often than he’s wrong. So let’s take a look at how long it would take for incomes to catch up to home prices.

Toronto Would Take 41 Years

Toronto home prices had a huge run over the past 18 months, sending home prices very high, in a very short period of time. In fact, mega bank UBS now calls it the riskiest real estate bubble in the world. The current home price to income ratio is 9.56, and we’ll assume Toronto doesn’t crumble after a correction, so a support would hold. At 30% lower, we get a support ratio of 6.69. If home prices stay flat, and incomes grow at a similar rate to how they’re growing today – it would take 41 years. Forty. F**king. Years.

Source: TREB, Statistics Canada, Better Dwelling.

Essentially, this wealth manager is advising people to pay a forty year premium on a home today. Remember all of the people that you’ve heard say prices will be flat until incomes catch up? They’re either lying, haven’t run numbers, or think you can pay the same price forty years later. Either way, their advice is close to useless.

This is a national issue, so people have to accept that incomes aren’t likely going to catch up to home prices. Will home prices come down, or should people be scrambling to get into the market then becomes the question. We’ll talk forecasting and a new model we’re working on called median credit market exhaustion in the next part.

Note: Sorry Vancouver readers, the talk was mostly about Toronto. We’ll have someone give Vancouver the same love over the next few days.

Update: Read part 2 here.

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