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Calgary Real Estate Price Elasticity of Supply June 16, 2008

Posted by DustinRJay in Calgary real estate, supply and demand.
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The supply of residential construction in Calgary has been tightly correlated with house prices over the past 30+ years.  High house prices lead to high levels of residential construction as increased margins encourage more market participants.

The following graph compares the amount of units under construction to house prices:

I believe this graph demonstrates that the Calgary real estate market is capable of oversupplying the market at the current price point and will continue to do so until developers margins are thinner.  Feel free to post your own interpretation below.

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Comments»

1. Spam - June 17, 2008

Ouch! I think this graph needs a legend and more annotation. What are you trying to say?

2. RJT - June 17, 2008

Interesting graph.

This is not news however. What it does illustrate, is that home builders respond to price signals (surprise). As prices/margins rise above historical norms, builders will take advantage buy building more.

The bullish RE agents out there kept telling me that we’re running out of land and that demand will always be greater than supply. What they seem to lack is basic economic understanding. When prices rise, supply actually increases (with a time lag), as this graph clearly shows. Also, over time, higher prices will destroy demand (also no rocket science here). In other words, supply and demand are dynamic, not static, and they respond to price.

Hence the RE cycle. When demand exceeds supply, prices rise. These prices then cause an increase in supply, and a decrease in demand. However, because these forces work with time lags, builders don’t realize that demand will slow down at high prices, so continue to build. This is why at the end of every real estate boom, there is an oversupply of homes, relative to the demand. This is why you see very high levels of inventory and very slow new home sales right now. As long as prices stay up, builders will continue to add to excess supply. The only way for the market to clear the excess inventory is for prices to drop.

If you don’t believe me, then look at the RE cycle from the boom US cities. Las Vegas, Phoenix, Miami, San Diego and many more, all saw prices go up very quickly over a few short years, followed by massive over-building and speculation, followed by a year or 2 of flat prices and climbing inventories, followed by prices declining like is happening now.

Calgary is not different. Many people who live here don’t understand those economics, but that won’t prevent the crash from happening.

3. Claeren - June 17, 2008

It is also worth noting that not only do builders/developers produce more units as prices rise each year, but they have also then created the ability to CONTINUE to build more units per year. The over-supply then is not just in the one year but rather extends until either the demand grows again to meet that higher capacity or until the suppliers lose their potential to develop so many units per month or year. Either one takes quite a bit of time.

Also saw this article out of the States today, saying prices are only halfway to their bottom with another 15% or so to go:
http://biz.yahoo.com/ap/080617/home_prices_bank_economists.html

We are just a year or so behind, with admittedly less downside but still….

4. Calgary Schmooze - June 17, 2008

I really appreciate the attempts at quantification contained in this blog.

Gary Shilling – a good friend of Robert Shiller – produces a monthly newsletter chock full of graphs and citations. A typical publication is about 40 pages and has upwards of 60 graphs or tables. He was one of the first to attach timeline predictions to his prognostications. His current outlook puts the end of the US housing decline at 4th quarter 2010 with aggregate values falling around 40%. He is mostly dismissed by the perma-bulls as promoting doom and gloom, but his accuracy is arguably around 80% for calling recessions and dislocations over the last 4 decades. If anything, his calls have been early on the time scale but they are pretty accurate on the “impact scale”.

As for downside, that concept is extremely relative to the persons affected. The destruction of the wealth effect that comes with accelerating asset values cannot be understated. People who were lead to believe that they “are richer than they think” typically spend on other big ticket items… so picking up that first house in late 2006 because the 2006 mid-year retention bonus was great and using the 2006 year-end bonus in early 2007 to snag a truck, trailer and boat makes you feel like a BSD… providing the cash flow continues to allow you to service all the debt. Any disruptions or unforeseen impacts to the steady-state and it’s close to game-over for a lot of people.

Personally, I believe we are going to experience time compression on our typical lag behind the Americans. The expectation that we might start to see similar effects in June 2009 may have to be moved up 6 months. For those attuned to details, there will definitely be signs to be noted in Alberta by the end of Q3.

5. Michael Oliver - June 30, 2008

I think this is a great graph, as the payoff becomes greater more people are willing to take the chance and more supply hits the market putting pressure on prices to decline. Here in Tucson Arizona (about an hour south of Phoenix, it’s actually Arizona’s second largest city.) we saw a huge raise in profit margins for builders and then so many homes came on the market and completly changed the real estate landscape. Now homes that used to be sold for 300k are available for sale for 225k or less! Now no one will build because the profit margins on the homes are so small its not worth the risk, this will only help our local real estate market.

6. section31 - July 4, 2008

I have noticed both housing and condo’s are down a good 10% since April. I spoke with an agent the other day and he/she said that allot of homeowners whom purchased in the past year or so are now having trouble paying there bills b/ of high mortgages they couldn’t really afford and now gas prices. I was told that allot of people have tried to get out of there house but they are now in negative equity positions in some cases and can’t. I feel really bad for them. I knew better than to get a house during this time so I am lucky. I would think we are looking at a recession here in Calgary no matter how well oil does and no matter how many immigrants we use to prop up the negative interpovincial migration.

On a lighter note, I can’t wait to buy a mcmansion in another year when they are like 1 less .3 of there original highs.

7. BradBender - July 10, 2008

I don’t know if you’ve seen this news or not: http://www.cbc.ca/canada/story/2008/07/09/mortgage-rules.html

Looks like Ottawa is changing the mortgage lending laws in Canada effective Oct 15 2008.

The changes include:
* Cutting the maximum amortization period to 35 years from 40.
* Requiring a minimum down payment of five per cent, whereas loans for 100 per cent of the price are possible now.
* Establishing a requirement for a consistent minimum credit score.
* Introducing new loan-documentation standards.

This should put a further dampening pressure on Calgary real-estate prices and we can continue the slow decline back to sanity (ie. 30% lower).

In the meantime I’ll be stocking my war-chest and hopefully in a few years I’ll be able to buy an average home with my above-average income in a manageable 25 year amortization.

8. randy - July 10, 2008

I was thinking about buying a home in calgary, when i seen then prices i was shocked to see how high they had gotten…I was in calgary about in 2004 and i remember seeing the prices back then, u could of got yourself a really nice house for 400k, but now your lucky u get yourself a cardboard box…..

9. Darrell - July 17, 2008

Randy,

Just wait. If the decrease in the US is any hint, it is coming north.

10. pete robison - August 28, 2011

I am a former Realtor in Calgary, now living and investing in Phoenix. On my web site I show the difference in values between Calgary and Phoenix for single family houses. I can buy a 1500 sq ft bungalow, 3 bedrooms, 2 bathrooms double attached garage and some with swimming pools for $75,000. As a front line investor, I can tell you, in spite of all of the negative news from so called experts, we are at the bottom. From 15 months supply, to less than 2 months supply, in the past 18 months, prices have started to rise. I also agree with one of the other contibutors, no area is immune from the law of supply and demand.

11. Noe - April 9, 2013

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12. Edmonton Insurance Brokers - May 29, 2013

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on the web. I most certainly will highly recommend this website!


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