Canada’s Housing Bubble Is Stretched to the Limit
Robert Morley @ theTrumpet.com
You have to empathize with people in Canada who want to buy a house. In boom cities like Regina, Saskatoon, Vancouver, Calgary and Toronto house prices have inflated virtually non-stop for more than a decade.
Income growth though—what income growth?
Consequently, it is virtually impossible for the typical person to purchase a home without bankrupting himself in the process. For many families, even with two incomes, buying a house is stretching beyond the breaking point.
In Regina, house prices have almost tripled over the past 10 years. Little 900-square-foot houses on small lots, built in the 1930s, and located in crummy neighborhoods, list for $200,000 or more.
This is Regina—middle of the bald prairie, nothing to stop the wind, more land than you could ever know what to do with, minus-40 degrees Celsius with only eight hours of daylight in the middle of winter—Regina!
If you want to avoid a coronary, don’t even think about buying a house in Vancouver.
In 1999, before the massive run-up in house prices, the price of a home was 3.2 times the average person’s salary. It averaged that for decades. By 2010, the average house in Canada cost 5.9 times the average yearly salary, according to the Globe and Mail.
Do the math: If you earned a salary of $50,000 per year, and bought an average house, it would cost almost $300,000. In Canada, this salary puts you in the 20 percent tax bracket. That means you really only bring home $40,000 per year, or $3,300 per month.
Now look at your mortgage costs. A 4.5 percent, fixed-rate, 30-year mortgage has a monthly payment of $1,520 per month. Almost half your total income goes to paying just the mortgage. That’s why the mortgage industry started providing zero-down 40-year loans, before the federal government banned them for being too risky for consumers.
If you are like many people, and don’t have a 20 percent down payment, you will need to buy mortgage insurance. Estimate another $250 per month if you have close to 20 percent. If you only put down 5 percent, you will need to cough up closer to $700 per month.
Then there are property taxes: Add at least another $500 per month. Property insurance: Another 250 per month.
You haven’t even begun to consider upkeep costs, or home owner’s association fees, and you are already paying $2,520 per month. If you only put 5 percent down, you would be paying $2,970 per month. That would leave you a miniscule $330 per month, all of which would probably be needed to pay utilities.
Talk about being a slave to your house. The average Canadian is forced to spend almost 100 percent of their income just on “ownership” costs! How do people feed themselves?
Of course that is why single-income families rarely buy houses in Canada anymore. To buy a house, both spouses need to work. One full salary goes toward paying for the house. The other salary goes toward feeding the family, paying for vehicles, paying other debt, and life.
But how dangerous is that? In the past, if the family breadwinner lost his job, the wife could temporarily get a job to keep the house from being repossessed. Today, if just one person loses their job, the family loses the house.
And Canadians rarely seem to consider the fact that their biggest investment might (read: will probably) go down in value.
Falling house prices is an idea that many Canadians laugh at. Americans laughed too before America’s bubble burst. Now, many Americans are locked into paying mortgages on houses that are becoming worth less and less each year.
Does this sound like the basis for a healthy economy? Indentured servitude for three decades just to see every dollar, dime and penny earned go toward paying for a depreciating asset! If you buy a house today, or if you bought a house over the past five to ten years, that is what you are risking.
And oh, if Canadians do default on their mortgages, banks can not only take the house, but have full recourse to go after all their other assets and income.
Yet Canadians seem more than willing to take the risk. Why? The same reason Americans did. When house prices are going up, it makes everyone rich! A 5 percent yearly gain on $300,000 is a cool $15,000—money that can be tapped through equity lines of credit.
And piling into real estate Canadians are. Offering interest rates yielding only fractions of a percent, the Bank of Canada is practically driving people into real estate.
In Vancouver, so many people are buying houses, second houses and investment houses, that the ratio of home prices to incomes is the highest in the English-speaking world, according to consultancy firm Demographia. The survey labeled it the second-least affordable city in the world! An average house there costs over 10.6 times the average pre-tax income. For further bubble evidence, check out this $1.2 million dump.
In Toronto, the real-estate bubble is so out of hand that the city has 173 skyscrapers under construction. New York, which boasts a population almost four times larger, is only building 96.
Since America’s housing bubble popped in 2007, Canada’s house prices have risen an astounding 22 percent. That has to be the definition of insanity—piling into the very investment that made your neighbor and most important economic partner virtually collapse.
But perhaps the biggest sign of a Canadian housing bubble is debt! Rising debt is the gas that fuels all bubbles. The average debt burden of Canadian families stands at a remarkable 153 percent of disposable income—and growing. It was only 150 percent three months ago. Canadians are now one of the most indebted people in the developed world, and just about as indebted as Americans before their bubble burst.
Based on this measure, the Economist figures the Canadian market is overvalued by over 70 percent. Even U.S. bubble epicenter Los Vegas has only seen house prices fall by 60 percent.
Last month, Merrill Lynch called Canada’s housing market overvalued, oversupplied and driven by speculation.
And in a report released last week, cibc argued that the people least likely to be able to afford new mortgages are the ones taking on new debt. One third of debtors hold about 75 percent of all personal debt. And who is this one third? According to cibc, it is boomers nearing retirement and those already burdened by high debt.
Canada’s bubble is getting close to bursting, and when it does, expect a massive economic implosion. Unemployment will soar, banks will fail or ask for bailouts, and the dollar will plunge in value. Millions of Canadians will be left paying a fixed mortgage on a rapidly depreciating asset that will destroy their financial lives.
Five years following the popping of America’s housing bubble, Canadians may be about to wish they had learned a lesson. Get your ear plugs ready. •
Canada’s real estate bubble: Spot the signs and prep for the pop
Experts say it’s impossible to say for certain when, or if at all, a bubble is going to pop. However, they agree that there are clear warning signs when things in the market aren’t quite right.
How many times have you seen headlines shouting that the real-estate bubble is about to burst?
In fact, experts say it’s impossible to say for certain when, or if at all, a bubble is going to pop. However, they agree that there are clear warning signs when things in the market aren’t quite right.
Darrell Cook of Edmonton’s Realty Executives Progressive recalls the real-estate bubble in the Alberta capital in 2006 and ’07.
“Supply was very low, and the demand for housing and investment property was great,” Cook says. “Our market saw multiple offers on many properties with a great number of homes selling above list price for a sustained period of time. At one point, some property values were increasing by $25,000 to $50,000 per month or more.”
Low interest rates coupled with rapidly increasing prices can create a storm of panic-buying with investors hoping to cash in, he explains.
“Buying a second or third property can be a great opportunity, but it can also be risky business, especially in a rapidly escalating market,” Cook says. “As a result of the bubble bursting in 2007, today many properties are still valued lower than they were at the height of the market.”
Craig Alexander, senior vice president and chief economist of the TD Bank Group, says that bubbles like the one that burst in Edmonton are always obvious—in retrospect.
“We can make educated guesses as to whether the price of real estate makes sense based on economic fundamentals,” the Toronto-based Alexander says. “But in truth we can’t actually predict with accuracy that something is a bubble until after it’s corrected.”
There are several measures that can be used to assess whether real estate is overvalued. One is the market’s price behaviour in isolation.
“Traditionally a bubble is formed when you have rapidly rising and accelerating price growth until such time when something suddenly changes behaviour, then it crashes.”
From this perspective, the good news is that in Canada, there aren’t the typical warning signs of a bubble nationwide.
Craig Alexander pictured in a handout photo
Housing prices cooled down in late 2008 early 2009 and have picked up again, Alexander notes, but they’re not escalating at the kind of breathtaking rate that would characterize an impending burst.
Another way to test for a bubble is to assess how the real-estate market is doing relative to underlying economic fundamentals in each market.
“You look at what’s happening with employment, what’s happening related to income and to capacity of households to borrow; you’re really looking at affordability,” Alexander says. “In other words, what is the behaviour of the prices of homes relative to average family income?”
Demographics also come into play.
“Over the long haul, the main driver of real-estate prices is household formation: the number of people you need to provide shelter for. If you have very strong population growth you can generally support stronger real-estate gains. If you have slowing population growth, you would expect some moderation in demand for real estate.”
Then there are geographical factors. Land scarcity—such as in Vancouver and Toronto, for example—drives up the value of real estate.
Put all those fundamentals together for an overall Canadian picture, and Alexander boils things down to this: “Our assessment is that on a national average basis, real estate is probably overvalued by 10 to 15 percent,” he says.
“It’s not a U.S.-style overvaluation. It’s not as dramatic as some market pundits are talking about. But if you actually unwound 10 to 15 percent overvaluation in a period of one year it would be a housing-market correction three times bigger than what we had during the early-90s correction.
“Again, it’s not US-style overvaluation, but at same time you shouldn’t be complacent about the risks.”
And there are certain Canadian cities that are closer to trouble than others.
“When you look at the fundamentals…the Vancouver market is definitely flashing a bright red light,” Alexander says. “Think of it as a graph: you can plot home prices in Vancouver versus personal income, and the slide looks like a hockey stick; it’s shooting up toward the moon. When you look at it, you think ‘That can’t last.’
“I can’t tell you whether something’s a bubble until after it bursts, but I can tell you when something makes no sense, and Vancouver home prices on the basis of domestic affordability make no sense.
“The other market we are concerned about is Toronto condos,” he adds. “There are so many condos under development there’s a fundamental question of the ability of the market to absorb them all as they come onto market.”
Based on economic figures, Alexander says two Canadian cities are flashing a yellow light: Quebec City and Montreal.
“These two cities are sending off a warning signal. The price growth that has happened in those two markets seems excessive relative to employment, income, and borrowing capacity.”
Alexander points out that sufficient data is lacking when it comes to Canadian real estate in general: little information exists regarding how much property is being purchased by foreigners or how much is being bought strictly for speculative reasons.
“This basically means you don’t have enough data to make definitive assessments, and this is one reason why you have debates,” Alexander says. “What I’m really saying there is overvaluation.
“The data that we have does not support the argument that there’s a big national bubble, but you could actually argue there are bubblelike qualities in certain markets. And Vancouver is definitely the market that is setting off most warning signals.”