Relying on rising home prices could be a fool's strategy: Don Pittis

New data from the Canadian Real Estate Association indicates the rules have suddenly changed for people trying to buyinto Canada's pricey real estate market.

The latest CREAfigures are not in themselves worrying, showing prices are roughly flat.

Of course, an average figure disguises wide differences in areas such as Toronto, where prices continue to soar, and Newfoundland and Labrador, where they have plunged by 10 per cent.

• Average Canadian house price barely increased in past 12 months

But if averages mean anything, Canada as a whole has reached a turning point where, on average, one of the strongest justifications for paying more thanyou can reallyafford for a home hasdisappeared.

The fundamental reasons for a slowdown in real estate are various.

A change in rules for foreign buyers has hit the Vancouver area. The crash in oil prices from the 2014 peak near $100 U.S. a barrel has hit oil-producing areas. For more sophisticated buyers, fear that North American interest rates will rise may be having an effect.

But the effect of flat property prices on potential buyers has much more to do with psychology than traditional market fundamentals. That does not weaken its effect.

Timing can be everything

Thejustification for overpaying for property or any other speculative asset issometimecalled the "greater fool" theory.

Former federal minister and business journalist Garth Turner wrote a book on the Canadian property market called Greater Fool: The Troubled Future of Real Estate.

Of course, if you had bought a house using the greater fool strategyin 2008, in most parts of Canada you would have done very well indeed. There have been few better investments.

But whenmarkets are changing direction, timing is everything.

The essence of the greater fool effect isthatbuyers may actually know they are being fools by buying overpricedassets. They walk in with their eyes wide open.

"It is possible to make money by buying securities, whether overvaluedor not, and later selling them at a profit because there will always be someone (a bigger or greater fool) who is willing to pay the higher price," explainsthe website Investopedia.

In the stock market, where prices can continue togo up due to popular euphoria long after a decline has been signalled, the greater fool strategy depends onbeing sure you are not the greatest fool. You mustselljust before the market madness ends.

Getting in deep

The danger in the Canadian property market is subtly different, because prices have been rising so quickly and untilrecently so reliably and because theprices are so high. The most important consideration may be that many Canadian buyers have been knowingly getting themselves in too deep.

"Perhaps most important, speculative fervour thrives on expectations of rapidly rising prices rising rapidly enough that buyers find it rational to make bets they could not normally afford," said The Economist magazine.

That quote was in an article about the market in collectible sports cards,but the phenomenon applies just as well to houses.

Getting inover your head maynot be a worry when house prices rise 24 per cent in a year, as they were at the beginningof last year in Vancouver.

But when house prices are no longer shooting up, Canadian buyers must begin to think seriously about whether they are still willing to go out on a limb with their finances when they can expect no bailout from a soaring property market.

And that can have its own impact on prices.

Other things being equal, without the reassurance that real estatewill keep rising, the most cautious buyers at any level willscale down their aspirations. They may be less likely to throwthemselves intobidding wars.

In many parts of the country, that has not happened yet. Bidding wars continue to hit the news. Just last week in Brampton, a city outsideToronto, a house attracted 500 viewingsand 82 offers, selling for hundreds of thousands over asking.

Lenders are usuallycareful to investigate the paying power of buyers, though maxing outthe bank's mortgage limit oftensqueezesout other spending, leaving buyers "house poor" and with little in the way of emergencysavings.

The federal government has adjusted mortgage requirements to make sure new homeowners have a buffer if interest rates rise.

It may be that the current slowdown in the rise of house prices ismerely a blip, a plateau before another climb.

People have to live somewhere. Perhaps the demand for new housing inareas of the country where the economy and population are growing will force desperate house hunters to continue paying more than theywould like simplybecause there is no alternative.

But when average house prices begin to go flat, it is reasonable that some buyers will exhibit greater caution. When markets are turning, no one wants to be the personwho paysthe highest price. Nobody wants to be the greatest fool.

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