500k is the New Million

MSN has an interesting article on how the prices of million dollar homes have deflated and now 500k will buy you homes that would have sold for twice as much in the heady days of the mortgage bubble. The nouveau riche who could claim to live in million dollar homes must reconcile themselves to their new pauperism (sarcasm intended):

But the gap between $500,000 and $1 million is more than monetary. It is also psychological. And during the recent boom years, Americans became reckless consumers, buying cars, houses, clothes and much more that they couldn’t really afford. The dream of a $1 million home, once so distant, became tantalizingly reachable.

Now that has all changed. While certain pockets, such as Manhattan, San Francisco and Boston, remain high, real-estate prices around the country have fallen dramatically. The downside to this, of course, is that many people now owe more money on their home than their home is worth. The upside is that valuations are much more realistic — and affordable.

The real estate bust is going to cause a lot of pain, but it is necessary. Overinflated housing prices put homes out of the reach of the young and those not fortunate enough to buy before the bubble grew. As noted, real estate should not grow exponentially. At best, it should be a bit more than inflation. Also, the price of an average house should not be more than 3 or 4 times the average household income. A mortgage should be a bit more expensive than rent, but it should not be much greater than what is paid in rent. When this is not the case, then you have a housing market that is clearly being fuelled by speculation and cannot be sustained.

The question now, is when and how quickly the housing market will go down. The signs are there. The Globe and Mail reported today that housing starts are way down and the building of condos is screeching to a halt in Toronto and Vancouver. The market is now oversaturated. Housing sales dropped by 50% last month and prices are going down. Of course, realtors are saying that Canada won’t experience a crash like the United States, but I do not buy it.

If you look at the evidence, house prices are overinflated in many markets, notably Vancouver and to a lesser extent Calgary, Edmonton and Toronto. Here, the average price of a house is much more than 3 times the average household income. Also, much of the rise in prices was due to speculation: people paying deposits on condos they could not afford in the hope of flipping the property once the condo was built. Money from these overinflated markets was then flowing to other cities: “equity” from Vancouver was used to buy properties elsewhere in British Columbia and Canada driving up prices there.

All told, Canada is due for a major housing correction. I see it as a good thing: lower housing prices will make life much more affordable for thousands and millions of people.

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