A bout a year ago, Simon Côté, managing director of property derivatives at National Bank, had a bright idea. He noticed that the market let investors bet their money on oil futures, bond futures, even canola futures, but there wasn’t a way to bet on the future prices of Canadian houses. So he decided to launch a whole new market, one that, among other things, would allow investors who think they know where the housing market is going to put money on it. If they thought house prices would go up by five per cent in a year, while others thought prices would go down, they could buy a contract saying so, and if they were right, they could rake in huge profits. The market would also be useful for investors who wanted to hedge against falling house prices. By buying contracts that paid out if house prices declined, they could help to recoup any money they lost in the housing market.
In conjunction with the forward market (like a futures market, but with contracts sold over the counter), National Bank also launched the Teranet-National Bank House Price Index, which tells us where house prices are at right now. The index uses data from Teranet, a respected but little-known company that manages the land registry database for the government of Ontario. Because every house sale in the province must be entered in the database by law, and Teranet has agreements with other provinces to access their data, Côté says the company’s numbers are much more “robust” than the house price data economists currently use. Because much of that current data comes from the real estate industry itself, the Teranet data can boast of coming from a more unbiased source as well.
When the Teranet market started up in December, it immediately predicted a shocking drop of 20 per cent, followed by an excruciatingly slow recovery that might not see prices return to last year’s high for seven years, or longer. It’s still young and thinly traded, but the Teranet market outlook is startlingly different from what most economists see. Last week, for instance, the Canadian Real Estate Association (CREA) predicted a drop of just eight per cent in 2009, followed by a speedy recovery that would see prices starting to edge up again in 2010. Most banks and investment firms (with the exception of Merrill Lynch Canada, which predicted a more significant drop followed by a slow recovery) fell into line with similar predictions of drops between eight and 12 per cent.
Just six months ago, the Canada Mortgage and Housing Corporation (CMHC), the government agency that insures billions of dollars worth of Canadian mortgages, predicted that we would actually see an increase in house prices of almost three per cent in 2009. It has since backtracked dramatically, issuing a new forecast three months later predicting an increase of just 0.1 per cent. Another revision was scheduled for last week, but the agency cancelled the release at the last minute, saying that the data needed more analysis than expected. They set a new date for the release, but they missed that date too. “Conditions in the housing markets really have been changing,” CMHC’s chief economist Bob Dugan says. “So we’ve been doing a series of revisions to our forecasts.” He says their latest figures now show that housing prices will go down in 2009. But that doesn’t mean he sees any real cause for concern, despite January’s largest-ever single-month job loss figures and our faltering GDP. “When I look at the economy as a whole,” he says, “I don’t really see the smoking gun.” He’s been scanning the numbers and just can’t see “the big scary indicators that say things are going south really terribly.” So he also predicts just a little dip followed by a quick recovery. “We think that house price growth is going to catch again during the year,” he says. “So year over year, you’ll see a decrease when you compare 2009 to 2008, but we think that during the year, prices will start to increase again.”
The sunniest forecast of all comes from Royal LePage, a national real estate company. In a recent release entitled “Correction, not crash for Canadian real estate market in 2009,” Royal says there will be a minor slip of three per cent, then “consumer confidence is anticipated to recover, prompting real estate activity to pick up once again in the latter half of 2009.” Phil Soper, the CEO of Royal LePage, says when you look at both prices and the volume of houses being sold each month, the market has already been declining since the end of 2007, so we’re due for a recovery soon. “We’ll hit bottom in about mid-year,” he says. “We believe that things will flatten out in the third quarter, and the recovery will begin for housing towards the end of the year.” He rejects the idea that the industry burnishes its predictions. “I can say absolutely that it does no one in the real estate industry any good to forecast home prices higher than the reality.”
So who’s right? The economists predicting a brief setback, or the futures market investors who see years of decline? Robert Shiller is an economics professor at Yale University and an internationally acclaimed expert on housing markets. He is one of the creators of the S&P/Case Shiller Home Price Index in the U.S.—one of the world’s most closely watched measures of real estate values. He says it looks like we’re in for the long decline. “I’d go with the futures market,” he says. “That’s called putting your money where your mouth is.”
Shiller says that when the U.S. market peaked in 2006, he saw the exact same situation we’re now seeing in Canada. Like us, the U.S. had just launched a futures market, and it was telling a drastically different story from the one the economists were pushing. “At first our market specialist thought the market would go up, but he immediately lost a lot of money,” says Shiller, “because the people trading on the market kept predicting declines. And ever since then, they have continued to predict declines.” Meanwhile, the economists were still talking of increases, or at worst, a minor correction. “The National Association of Realtors had economists that were boosting the market all the time, and doing everything they could to get people in,” says Shiller. “Their chief economist, David Lereah, even wrote this dreadful book called Are You Missing the Real Estate Boom? He wrote that in 2005, just before the peak.”
Shiller says that futures markets are better predictors because while the predictions made by CMHC, for instance, represent the opinions of one or two economists, the predictions made by a futures market represent the combined best guesses of many investors who are so convinced of their forecast, they’re willing to literally bet money on it. As New Yorker writer James Surowiecki detailed in his bestselling book The Wisdom of Crowds, such prediction markets tend to be more accurate than individual predictions, both because they are less biased and because the collective wisdom they draw upon is more powerful than any one economist’s best guess.
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