AMA - High End Property Pricing

Today’s question comes from Richard in Ottawa, Canada. Rich asks,

With materials costing more and labour being harder to get, wouldn’t it make sense that high end/newer homes property values will go up over the next 12-18 months? Doesn’t less supply = higher demand?

Rich this is a great question. Supply and demand are independent variables. Less supply doesn’t actually mean higher demand. We’re concerned with the balance of these two independent variables. More supply than demand and prices will fall. More demand than supply and prices will increase.

You are correct in pointing out that construction costs have increased. There are two reasons for that.

1. We have experienced supply chain disruptions which have affected materials prices.
2. There is a shortage of labor

Paradoxically, the labor shortage exists at a time when we also have millions of people unemployed. When the pandemic hit we actually saw labor prices drop to more historic levels as people in construction saw projects being put on hold.

If you peel back your question to the most fundamental, it seems like you’re really asking whether making an investment in a particular segment will be a safe investment in the newt 18 months. It’s a little like asking to predict the future. None of us really know.

Economists try to understand the current market conditions and construct a model for how the economy functions. If that model is accurate it can be useful for predicting the near future as long as the major variables don’t change. Therein lies the difficulty. We have a lot of variables that could be easily described as headwinds or tailwinds. The direction of the economy and the local market conditions will be the sum of all those headwinds and tailwinds to see what the net result will be.

1) Because of the pandemic, most people who might consider moving have put those plans on hold. They’re staying put. That has taken supply of homes for sale and for rent off the market.

2) The low interest rate environment has definitely been a tailwind.

3) We have seen prices increase across many markets in North America. The national average is 11%. But this isn’t uniform at all. Some cities like Nashville and Austin continue to experience population growth.

Let’s look at the headwinds.

1. We have millions of people unemployed. We have political gridlock in Washington and we have a minority government in Canada where the threat of the government falling is increasingly likely. We have businesses failing all over the place.
2. We have oil prices falling which means billions of dollars in write downs in the energy sector of the economy.
3. We have between 8-9% of the residential mortgages in the US in some form of distress. We have millions of tenants who are behind on their rent payments. In our own province of Ontario, we have a backlog of over 80,000 eviction motions in front of the landlord tenant tribunal. These properties have not hit the market yet. They represent a shadow inventory of sorts that will eventually appear on the market in distressed condition.
4. Travel is restricted due to the pandemic, and therefore immigration is well below historic levels. That too is a headwind.
5. People are dying in large numbers as a result of Covid-19. The US has seen nearly 0.25M deaths. When people die, that brings more inventory into the market increasing supply. That’s another headwind, albeit a small one compared to the others.
6. Finally, the US Federal election is likely to bring an environment that will not favour the housing market.

So we’re trying to make sense out of all these variables and predicted how they will all play out.  There are a lot of variables and the outcome is highly uncertain. Remember, back in 1929, the economy was booming. Everything looked rosy and optimistic, until it didn’t.