The only real estate market any of us have ever known has been hot, hot, hot!

But what happens when there is more supply than demand?  What happens when supply is ten, twenty, or thirty times greater than demand?

How does the market absorb the inventory?

The motivation behind this post stems from a storey a friend of mine told last night after our hockey game.

After a 6-2 victory in a very chippy, physical game, six of us headed out to Brass Taps for a pint and some half priced wings, and two of the guys brought their girlfriends along to ensure we got our daily dose of celebrity gossip…

We spent a good chunk of time talking about how to clean smelly hockey equipment, as well as a spirited discussion on whether or not Megan Fox is a tramp, but the most interesting conversation came when we began to talk about what else – real estate.

A friend-of-a-friend on my team named Alex comes from a family of real estate investors.  I don’t know much about the guy other than the fact that he has a wicked slapshot, but I also know he is definitely very well versed in international real estate.

I was talking about the potential of buying the condo that is two doors away from me, since I believe it to be undervalued and November is the wrong time to showcase a 505 square foot condo with a gorgeous 440 square foot terrace.  How about June when the flowers are in bloom and the BBQ is cooking up prime rib on your terrace that is larger than some bachelor condos?  Anyways…

I surmised that I was at somewhat of a crossroads in my investment horizon.

I’m not sure whether my next move is to purchase yet another property in our Toronto market, stuff my money in my mattress, or perhaps look outside our Canadian border.

My friend Chris said, “Well the U.S. is on it’s knees right now.  You could probably throw a dart at a map of the country and end up making money on a property wherever you buy.”

True.  But where can you make the most money?

I said, “Maybe it’s time to buy my vacation home?  It’s about 10-15 years earlier than I expected, but the prices down there are unreal!”

My hard-working right-winger, Grant, said “Yeah they’re basically selling houses 2-for-1 down in Phoenix.  It’s unreal cheap.”

But then Alex spoke up and said something that I think we all knew, but none of us were thinking about.

Heck – let’s even go as far as to say that some of the people sitting at the table had never given this simple statement any thought.

Alex said, “Sure, it’s cheap – but do you know how long it’s going to take for the market to absorb all that inventory?”

The table went silent….for about three seconds, which is as long as a post-hockey-game table can be silent for before somebody spills beer or bites into a hot wing thinking it’s a mild one.

A picture paints a thousand words, so look at this photo below:

To echo the words of my last girlfriend, I ask you all, “Sooooo…..what are you thinking?”

What do you think when you see this photo?

Talk about “the other side of the tracks!”  This photo clearly demonstrates how readily available housing can be in some areas.

We’ve never known any market like this; living in downtown Toronto where people routinely pay $500 per square foot to live in the sky.  But imagine a neighborhood, a town, or a city where there is so much land and so many houses that the prices just aren’t going to increase.

In this photo above, we see a sub-division where I would assume many of these houses are unsold.  The area is obviously brand new since there are no mature trees, and perhaps this neighborhood was forged from a farm or some cheap swamp land that nobody wanted.

On the other side of the road, we have what is called “serviced land” with no houses.

Serviced land is land that is basically ready to be built on as all the sewers, electricity, water, roads, and bridges have already been built and installed.

This land won’t be built on until there is demand….in theory, at least.

But what happens when developers don’t wait for the demand?

What happens when they speculate that the demand WILL arrive?

What happens when they go ahead and build without any sales contracts or potential buyers?

I think these questions are rhetorical enough, don’t you?

All across North America, there are mazes of unsold houses just like the one in the picture above.  Whether it’s Phoenix, Florida, or vacation properties like the ones in Idaho that I wrote about in the summer.

What value can these homes possibly have?

Let’s assume that at one point, these houses were “worth” $1,000,000.  Maybe the developers speculated that the houses “could” sell for $1,000,000, but nothing has ever proved this to be the case.  Even if 2-3 investors jumped the gun and shelled out a million-bucks, there could still be a thousand unsold houses, with no current price.

If these houses are now for sale for $500,000, would you consider it a “deal?”

How about $400,000?

What do you say to $250,000?

If there are houses that once upon a time were “valued” at $1,000,000, and you could now get your hands on them for a paltry $250,000, don’t you have to at least consider it a deal?

Maybe not.

In that photo above, let’s assume that there are 450 houses in that sub-division and 420 of them are unsold.  Would you pay $250,000 for one of those houses to be the 31st proud owner?

How long will it take for the market to absorb the inventory that remains?

And if and when the other 419 houses are sold, the developer will build another 450 across the street!

What could possibly drive the market UP as opposed to down?

My slapshot pal, Alex, believes that there are some areas where it will take 50-100 years to absorb the inventory.  In areas like Phoenix where maybe 2,000 Canadians per year were buying vacation homes, developers and speculators built 50,000 homes thinking they would cash in on the demand.  But you can’t expect prices to remain the same when you throw the supply/demand equilibrium completely out of flux!

You’ve got 100 buyers.

You’ve got 100 sellers.

The market is in perfect equilibrium, and prices stay the same.

Now imagine you’ve got 100 buyers, and you’ve got 1,000 sellers.  Don’t you think prices are going to drop dramatically?

Speculation is among the key reasons for decline in any marketplace; stock market, real estate market, what have you.

There are areas in North America where speculation got so out of control that developers kept building and building even though there was nobody around to buy their product!  Now these areas are so overbuilt that the unsold inventory continues to pile and pile, and the prices continue to drop and drop.

Alex is right – there are areas where the unsold inventory will take years and years to be absorbed by the market.  Some of this may not even happen in our lifetime.

Alex said, “Why not just buy a condo in New York?  New York has been hit hard just like the rest of the U.S., and maybe prices aren’t down 85% like in some areas of friggin’ rural Nebraska where the property values were completely made up to begin with, but New York will always be New York, and the inventory will always be needed.  The market will come back.  You can’t expect the markets in Florida or Phoenix to ever recover with all that inventory available on a whim.”

Well said.

New York’s real estate market hasn’t dropped because there is too much product, but rather due to political and economic factors that have caused even the most expensive real estate on the continent to decrease in value.

So now, I’d like to make a comparison to CityPlace, since I received FOUR emails yesterday from angry readers after my blog post.

CityPlace has “value” now because there is a lack of supply in our Toronto market place.  Residential listings are down 42% from the same period last year.

BUT….when the supply in our city eventually becomes even with, and begins to exceed the demand (which will happen at some point – despite the market’s current, frenetic pace), it is CityPlace that will be hit the hardest due to the massive amounts of inventory.

Let’s assume that with the snap of my fingers, tomorrow we dive into a massive recession.  There are about 5,000 units currently under construction at CityPlace.  Do you think these units would be an easy sell?  Do you think the resale units of the other 11,000 units at CityPlace would hold their value?

CityPlace is cheaply constructed, crudely designed, quickly built, there is a ton of inventory with more on the way, and there is adjacent land to provide even more after that.

I can’t think of a better comparison to the sub-division in the photo above.

Can you?