Are bidding wars back?

Apparently, bidding wars are back in the Greater Toronto area real estate market, according to reports from Redditors and realtors alike. In this week’s analysis, I will dive into this trend and provide an analysis of a specific listing that garnered 85 offers. This case study offers valuable insights into the current state of Toronto’s real estate market heading into 2024’s spring market.

Bidding wars of this magnitude are like… soooo 2022. Maybe even 2017. They have no place in this market, right? Right?

Wrong, apparently.

From where I stand there are a few key things we can learn from all of this taking place on the forefront of a recession.

1. People are generally unaware of seasonality
2. Bidding wars are a symptom of a much bigger problem with realtors
3. There is a lot of demand concentrated below $1,000,000 (and why)
4. Bidding wars don’t necessarily have to be a bullish signal

So, the original post above was deleted on Reddit - but fortunately Nasma had the foresight to put a screenshot on Twitter, which you can see below:

While there was a number of great comments - the one thing that stood out to me here is the author’s sentiment that it was similar to 2022’s run-up. It may be more worth considering a comparison to last year’s spring market, which was the largest price growth we’ve ever seen in a 5-month period in Canada. You can see a seasonal price trend comparison by @phfloor below:

In a halfhearted attempt to remind people that seasonality exists - I’d just ask that you please observe the following general pattern of house prices on that chart:

1. Prices rise in the spring
2. Prices fall in the summer
3. Prices rise in the fall
4. Prices fall in the winter

A lot of this happens due to a skew in data. The easiest way to understand this is as follows:

• Families have more people, so they need bigger homes
• Families prefer to buy in the spring to close during the summer break;
• Bigger homes are worth more money;
• More homes worth more money sell in the spring, pulling price indices up.

I’d also ask that you observe that the steepest increase you’ll see in house prices takes place from January to February.

Robert Marsiglio did an excellent analysis on this - a really excellent one. I wish I did it, honestly:

According to the below chart from REMetrics.ca, you can observe a rise in bidding wars in the data, although not reaching the same level as the spring market of last year. Therefore, while there may be an increase, we have not yet entered a highly competitive market.

• The increase in bidding wars in January is not as substantial as the number of properties selling above the asking price during the spring.
• The proportion of properties selling above the asking price in the GTA has increased from approximately 15% to nearly 20%,
• This is still well below last year’s spring market, which saw over 50% of properties sell over asking.

And this is where I think it’s worth noting a phenomena that takes place every year that shows me how people just don’t understand seasonality, supply and demand, or equilibrium price (and that’s fine, they’re complicated concepts).

1. Seasonality

At the beginning of every year, buyers enter the market. Many seem to do so exceptionally fervently in January, for some reason. It could have something to do with annual goal setting, honestly - new year, new me and all of that. In December, volume basically falls off, and buyers hibernate for a bit. This creates a bigger pool of buyers as perhaps some enter the market. Perhaps some get divorced over the holidays. Perhaps some parents gift their kid a downpayment for Christmas.

So let’s say that in January, you have most of the buyers for this year’s spring market, and they’re looking for houses.

Eager buyers seem to try to front run the spring market while snow is still on the ground. There’s not much supply, because January and February suck for getting a house ready for sale. As a result, the market is in a temporary state of excess demand. You see a big jump up in prices. Sellers see those prices. Sellers decide they like those prices. Sellers start hurrying to put their properties on the market. More supply comes online, and buyers have more options. Price growth settles. Listings start coming off the market for the summer. This is how you go from excess demand to equilibrium supply and demand at an equilibrium price.

2. The Bigger Problem

Now, assume all of those buyers in January see a house that appears to be available at a 30% discount. They notify their realtor, and their realtor should probably tell them that the house is worth about $950,000, and they’ll decide whether or not they still want to see it.

This is the point where I think it’s worth acknowledging that there is a much bigger problem here. Last year, the average number of deals per realtor on the Toronto Real Estate Board is below 1.5. The biggest group of realtors are those who do one or less deals per year. This means that it is statistically likely that you are the only client your realtor represents that year. That is a problem.

And that is a problem which the more shrewd, experienced agents can, and will, often exploit to create a high-pressure sales environment that benefits their client, the seller.

Do I think the property could have sold at the same price with 90% less showings and 90% less offers if it was priced at $999,999? Yes.

Do I think it’s economically wasteful? Sure.

I’ve discussed this at length before. And I’ve had the discussion privately with this listing agent before, since we work at the same company. They happen to be a top agent in the city, so who am I to say what’s right here?

Did the agent do their job and represent their client’s best interests? Also yes.

So… who is the bad guy here? The realtor who underlisted, or all of the agents who didn’t realize and advise their clients how far it was underlisted? Now you understand how and why the Toronto real estate market is fundamentally broken.

3. Excess demand below $1,000,000

Compounding this, the property was likely pursued as a purchase by first-time homebuyers. How do I know this? It’s simple - the price is a price paid by a homebuyer using an insured mortgage, and nobody paid a penny higher than $1,000,000 for the house.

But… why not?

To answer this, let’s consult CMHC’s General Requirements:

“For CMHC-insured mortgage loans, the maximum purchase price or as-improved property value must be below $1,000,000.”

After 85 offers, the sale price was $999,999.

Not $1,000,000. Not $1,000,001.

This means that not a single buyer was willing or able to pay $1,000,000 to win the bidding war/auction.

Why not? Now you know why.

This tells me that the price floor is cemented by insured borrowers, which are backstopped by you, the taxpayer, by the way. This also means that any growth we’ll see in the real estate market this year will come from that price floor being pushed up.

This is a big problem from my perspective, for a few reasons:

1. These buyers have little experienced, as evidenced by the lack of understanding of seasonality I mentioned before
2. These buyers are more likely to be ill-advised by working with less experienced agents
3. These buyers are incredibly high leverage, often negative-equity.

What? Check my math…

CMHC charges a 4.00% insurance premium to insure a 95% LTV loan. That 4.00% gets added to the principal amount, which now becomes ~99%. This means that the borrower has 1% equity when they take possession of the house, not accounting for land transfer tax and closing costs.

In order to sell that house, that owner would incur a minimum of 5.00% in switching costs (mortgage discharge, pay a realtor, lawyer, etc.). Therefore, the buyer would have a 4.00% equity shortfall.

You can repeat this math at 90%, where the premium is 3.10%, leaving the buyer with 6.90% equity before switching costs, or 1.90% after switching costs.

So, if the market drops by 1.90% - they’re in negative equity.

If they overpaid by 2% - they’re in negative equity.

The stakes are high where the leverage is high.

4. No FOMO

The last piece I’ll leave you with is this. Bidding wars are happening, but it doesn't necessarily mean that house prices are going up. Realtors can and will continue to underprice the market because it makes their job easier, and sellers will continue accepting the best offer they get. And that is what’s taking place, as the average list price has been in decline since peaking in 2022.

This can actually expedite downward price discovery, because if the seller market is willing to accept 110% of asking price, and asking prices are in decline, sellers can chase buyers down, and buyers can still be price-setting, in spite of paying over asking price. Weird, right?

Now let’s look at the property in question… the one with 85 offers.

It sounds bullish right? The house had 85 OFFERS.

This must be a sign that prices are going nuts. Right?

The property was listed at $750,000, pretty close to its 2017 sale price of $735,000, as noted by twitter and reddit.

With 85 offers, it sold for $999,999.

This is only 35% higher than the $735,000 it sold for in 2017, or 4.38% per year using a compound annual growth rate (CAGR).

4.38% is just above the 100-year average house price growth in Canada, which is 4.11%

Bull market?