By Tom Bradley
A common phrase used in economic and investment circles is ‘soft landing’, which is defined by Investopedia as, “an economy that has avoided a strong contraction.” In other words, after a long rise, not much of a drop.
The term is being used repeatedly right now to describe where the Canadian housing market is heading. For example, an article in Advisor.ca confidently predicts that condos are headed for a soft landing. The consensus amongst Canadian bank presidents is similar for the overall housing market. Their view is that when the housing boom comes to an end, prices and volumes will flatten out, or drop modestly.
Certainly ‘soft landing’ has a nice sound to it. Comforting actually. But I’m not as sanguine because I’ve yet to see an economic or market cycle that (1) is running well above the long-term trend and (2) has been going on for many years, land softly.
Soft landings are rare occurrences for a number of reasons:
- Greed - Near the end of a cycle, the market psychology is not conducive to good decision-making. People are buying because they don’t want to miss out, not because the economics are compelling or the purchase fits with their long-term investment plan.
- Weak hands – For greed-related reasons, more assets are held in weak hands at the peak of the cycle. In other words, when a slowdown comes, many buyers aren’t willing or able to deal with adversity.
- Debt – At the end of the cycle, leverage is at a maximum. Any subsequent deleveraging puts pressure on prices.
- Fatigue – After a long cycle, it gets to the point where most people have already bought, or at least their adrenaline has stopped pumping.
- Economic circumstances change – The favourable forces that pushed the market well above the long-term trend don’t go on forever. At some point, some of them will dissipate or reverse.
- Valuation – As with any asset, valuations will swing like a pendulum. When everything is good, anxious buyers push prices to the expensive side of the arc. When the sellers become the anxious ones, the pendulum swings back.
- Increased supply – Money goes where the profits are. Success encourages increased investment, which translates into more supply than is needed.
Despite the consensus, I think it’s a bold prediction to say the housing boom will come to an end softly. I say that because complacency around mortgage rates and prices makes the market psychologically vulnerable. Canadians’ borrowing binge is getting downright unhealthy. The first-time buyer segment of the population (25-34 year olds) is flattening out after going through a growth spurt (bad pun). And valuations are stretched, based on a number of measures, including the rental return.
Maybe the biggest reason Canadian housing will experience a rough ride is because the term ‘soft landing’ is being used so often. Pronouncements of soft landings usually means there’s a good chance we’re headed for a hard landing.