Tuesday, May 29, 2007

Yes Virginia, we have a bubble in Alberta Real Estate

They may say there's no bubble….
But we do know that stock brokers generally never say that there's a bubble in stock market. Oil companies will never say that oil prices are high. Realtors will never say that real estate is expensive, leave aside in a bubble.
And they are right.
Abby Joseph Cohen, the famous stock market bull said that there is no bubble in NASDAQ in 2000. The now (in) famous Professor Fisher also said in 1929 that "stocks have reached a permanent plateau". Even Greenspan said in 2000 that it's hard to argue against the wisdom of millions of well informed investors.
At different times over the last several centuries, asset bubbles have appeared in different parts of the world. One of my favorite books that documents this is the 'ExtraordinaryPopular delusions and madness of crowds' that illustrates some of the well known delusions of the crowds.
But let's begin from the basics. What is an asset bubble? Here's my understanding: An asset bubble is a significant rise in asset valuations fueled by greed and mass frenzy into buying that asset class. In the post-modern world, it could be due to the ease of availability of credit, lose lending standards, media propaganda and the beliefs that xxx-asset never goes down (xxx could be anything ranging from tulips to real estate in Tanzania).
A bubble does not appear out of nowhere. A bubble is usually preceded by a healthy bull market. The last stage of the bull market gives way to an asset bubble. The defining characteristic of a bubble is the disconnection with the fundamentals.
For example, a two bedroom condo that was selling for less than $100k in March 2005 and renting for around $800 in Edmonton now sells for roughly 3 times that amount. What has changed in two years? Have the rents gone up by 3 times? Has the average rent moved closer to $2400 per month for such an apartment?
Have people's incomes gone up by that much? Exactly what has caused this dramatic jump then? I think it's the massive speculation and 'investor' interest in such properties that has caused such an increase in prices. Every mania needs a story and the oil sands are the Alberta's story.
No doubt Alberta has oil sands. But it also has more land than most countries in the world. And this is soft arable land where you can dig a foundation with a shovel!
And we are around 4 hours away from one of the largest timber producing regions in the world, and the last I checked the timber prices were falling.
There are a few things that should be pretty obvious. There was (and probably still is) strong demand for housing in Alberta. That should have boosted up the prices, but not to the extent that they have gone up. The prices are now disconnected from long term fundamentals-abundance of land, ease of availability of building material and worsening affordability. Also, it looks like the days of cheap credit may be coming to an end with BOC signaling higher interest rates in coming months.
There's just one factor that is holding the prices high at this point and that is the labor shortage. And when the labor shortage eases, a lot of people will discover the extent of builder margins in this market.
And finally, just to let everyone know, I don't have an agenda. I'm bearish on real estate in Alberta, but I'm bearish on pretty much most asset classes across the world. That could range assets as varied as real estate in India to stocks in China.
The problem is that for almost all these markets- real estate in India, stocks in China, real estate in Alberta or Vancouver-there is a plausible story. In India it's the emerging market story harnessing the outsourcing cost advantages. China is the manufacturing superpower of the world and nothing can stop it from growing perpetually at ten percent per annum. Closer to home, of course, there are oil sands and in Vancouver there is the Olympics.
So everyone is different, but still the same. Everyone believes they are different and they are right. But most asset classes at this point are expensive and in that regard they are all the same.

It will be interesting to see how things will unfold in the coming months with rising interest rates and loads of inventory coming to the market with poor affordability. And this is with oil still above $60.
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