Rarely does a week go by when there isn’t a new economic forecast about the real estate market. For nearly a decade, the negative forecasts have been predicting a 25% decline in house prices while the positive ones have been predicting a “soft landing” for Toronto’s real estate market. Both predictions have yet to come true.
Readers often ask me how this is possible. How can so many economists be so wrong about the market for so many consecutive years?
While there are a number of reasons why economists are poor forecasters (Nobel-prize winning psychologist Daniel Kahneman's new book Thinking, Fast and Slow suggests that most experts, like most humans, are not as clear-thinking as they'd like to be due to the way the human mind operates), I’ll focus on some of the key problems that have been top of mind with me lately.
Firstly, the real estate market has historically been the realm of the macroeconomist. Macroeconomists will study aggregated indicators like GDP, unemployment, interest rates and household income to understand their impact on the real estate market. While these kind of macroeconomic indicators are of course important and do impact the real estate market, they are far too broad to really give us a strong understanding of what’s going on in the actual market.
Even when economists look beyond national and provincial data to focus on indicators for a particular city, this too can present considerable challenges. In many instances the data economists use, through no fault of their own, is either inaccurate or misleading.
The real estate market requires a stronger emphasis on microeconomic principals if one truly wants to understand where the market is heading. Microeconomists study the individual decisions and behaviours of households and their impact on supply and demand. More importantly, they track the spread of such decisions and behaviours, identifying the trends that really shape the real estate market.
To illustrate my argument, I’ll look at two common macroeconomic variables that economists often use when studying the real estate market - average house prices and changes in rent - and why they are problematic.