The media have stepped up the real estate bubble rhetoric lately so I thought I would take some time away from the busy spring market to offer my thoughts on the one question that’s on most people’s minds, is the Toronto real estate market going to crash?
Most buyers are worried about buying at the peak of the market and with all the bubble talk in the mainstream media they are right to being asking themselves, is this the peak?
If we have hit the peak then we would expect to see a decline in house prices within the next 6-12 months.
So what causes house prices to fall? There’s actually only one basic economic condition that will cause house values to fall, when the supply of houses coming on the market for sale significantly out numbers the demand for homes. There could be a number of different factors that cause demand to decline or the supply of homes to increase but it’s the imbalance between the two that drives house prices down.
With that in mind, we’ll start off by taking a look at the balance between the supply and demand for houses in the resale market.
We can measure the balance between supply and demand by looking at the sales-to-inventory ratio for any given month. The sales-to-inventory ratio is simply the number of houses that sold in a month divided by the number of houses available for sale. In a balanced market we would expect to see roughly 2 houses selling for every 10 that are available for sale, or a 20% sales-to-inventory ratio. When the sales-to-inventory ratio is above 20% the demand for homes exceeds the supply which causes prices to rise and similarly when it’s below 20% the supply exceeds the demand which causes prices to fall.
The following chart shows the relationship between the sales-to-inventory ratio and changes in house prices from 1989 to April 2012.