Is Canada’s Real Estate Bubble About to Pop?

The verdict is in: Canada’s housing market is in big trouble and the end of the country’s real estate bubble could begin in 2016.

In December 2014, the Bank of Canada reported that as things stand, the nation’s housing prices were so inflated that they were 10% to 30% overvalued. (Source: “Financial System Review,” Bank of Canada, December 2014.) However, the problem could now be much worse. Some economists have chimed in to say this is actually an understatement and a catastrophic Canadian housing market crash could be coming in 2016.

Canada Real Estate Crash 2016

Corrections in housing markets tend to have a cascade effect on overall household finances. This is due to the fact that, typically speaking, home ownership involves large amounts of financial leverage.

Put simply, for every 10% drop in the price of a person’s home, they lose approximately 20% of their overall net worth. However, the situation would be far more complex and dire in hot Canadian housing markets such as Vancouver and Toronto, where leverage is typically far higher than the national average. (Source: “Canada’s housing market to become drag on the economy: poll,” The Globe & Mail, December 1, 2015.)




Canada’s federal housing agency has announced that it expects to see more and more homeowners defaulting on their mortgage payments on the West Coast, particularly in the province of British Columbia. (Source: “CMHC warns that Canadian housing market is overvalued in most major cities,” The Financial Post, October 29, 2015.)

The ongoing oil price crash is certainly not helping matters, as the energy sector is a critical part of Canada’s economy. The Canada Mortgage and Housing Corporation, the insurer of the majority of Canadian mortgages, announced that energy sector issues have not yet affected homeowners’ capacity to make their payments on time. However, stress cracks are expected to appear soon. (Source: “House prices could fall 26% if oil hits $35 and stays for 5 years: CMHC,” CBC, December 1, 2015.)

Experts agree that when the wave of arrears does come, the red-hot housing market along West Coast Canada will be hardest hit. While the Canadian housing market has absolutely boomed since the financial crisis in 2008–2009, especially in the urban zones of Toronto and Vancouver, these are not the only areas of concern identified by analysts as being primed for a housing price collapse; other regions of Canada are also at risk.

While there is a broad consensus on the state of the current housing market, analysts diverge in opinion when it comes to how best to deal with things as they stand. While some economists believe that increased lending standards and regulations will lead to a soft landing when the Canadian market does correct itself, others have predicted we are far more likely to see a massive crash, similar to what happened in the United States.

The Looming Crisis for Canadian Real Estate

The average Canadian home price has risen by 5.6% over the last 12 months, as the bubble grows ever larger. (Source: “Canada’s Housing Slowdown ‘Seems To Have Arrived’—Just Not Everywhere,” The Huffington Post, November 12, 2015.) But there’s one fact that often goes unmentioned when people talk about the looming Canadian housing market crash and that’s the baby-boomer bulge.

Many analysts believe that as the Canadian population gets older, the mass influx of baby boomers entering retirement will lead to the unraveling of a tightly wound, but ultimately fragile, housing market. But the effect may not be quite what you think.

When it comes to predicting the future of the Canadian housing market, the key to better understanding the situation is analyzing demographic trends. Shifting demographic patterns are pointing towards an impending disaster and need to be taken into account. When you cut to the heart of the issue, Canada simply has more people exiting the workforce than entering it. In fact, there are fewer people entering the Canadian workforce than ever before!

If a report by the Bank of International Settlements can be believed, demographic trends play an absolutely critical role in the financial health of an economy and housing markets in particular. (Source: “Can demography affect inflation and monetary policy?” Bank of International Settlements, February 2015.) If you have more people exiting the employment pool than entering it, as Canada’s patterns show, the economy, as a whole, tends to contract.

But that’s not all, because one must also consider the direct impact that a rising wave of older homeowners selling their homes will have on the market. The typical age range in which homeowners start thinking about and eventually selling their homes is when they are approximately 60 to 70 years old. The baby boomers, Canada’s largest generational group, are now entering that phase.

This begs a simple, yet extremely important question: with a large group of older folks trying to sell homes at inflated prices, just who exactly is going to buy them?

I’m talking about simple supply and demand dynamics here and the implications for the Canadian housing market could very well be profound. Older people are putting up their houses for sale in increasing numbers and in today’s ever-growing bubble, it shouldn’t surprise anyone that they aren’t quite getting the offers they might have expected. High-priced older homes are often taken off the market as younger buyers, eager to get into the equity-building game, pass up better-quality, more expensive homes in favor of newer, more affordable housing developments.

Canada tops the charts when it comes to housing prices. In fact, The Economist ran a piece earlier this year in which it recognized Canada’s housing market as being the most overvalued out of 36 advanced global economies. (Source: “Moody’s, The Economist warn of high Canadian debt, housing prices,” CBC, October 19, 2015.)

Sounds alarming? It is. However, this is only the tip of the financial iceberg facing the so-called Great White North. Australia and Canada were identified as the top two countries in which prices were the most out of sorts when compared to income levels. (Source: Ibid.) The main culprit appears to be the prevalence of cheap money, in which lax borrowing conditions have led to home purchasing levels gone amok. This has had the effect of providing an artificially high uplift to Canadian housing prices.

Global Investors Bailing on Canada

And it’s not as if people did not see this bubble coming, because the looming Canadian housing crisis has been cooking for a long time.

In a report published in January, Deutsche Bank called Canada the most overvalued housing market in the world. Based on historical measures like price-to-rent and price-to-income ratios, Deutsche Bank argues the nation’s real estate market is 63% overpriced. (Source: “Canada Housing Market Is 63% Overvalued: Deutsche Bank,” Bloomberg, January 8, 2015.) The writing has evidently been on the wall for a long time now, and analysts have not been slow to notice.

Would it surprise you to know that global investors are hedging their bets when it comes to the Canadian housing market? Investors have been betting against the Canadian housing market in growing numbers and their wagers may be about to pay off.

An increasing number of investors are taking out short positions on Canadian banks, insurers, and other companies that deal with mortgage lending services. (Source: “Why investors are shorting Canada’s housing market,” CNBC, October 30, 2015.) In simple terms, what this means is that investors are putting their money on an upcoming Canadian housing crash causing a fall in the stock prices of these companies.

One of Canada’s largest mortgage lenders, Home Capital Group is now carrying the unwanted title of most-shorted stock in the whole country. (Source: Ibid.) If you think this is an anomaly confined to just one failing company, then think again. Three of the top 10 most shorted stocks in Canada are financial institutions with heavy exposure to the housing market.

Now, one of the key underlying problems to do with the U.S. housing bubble crash back in 2008–2009 was mortgage fraud. This is primarily where less-than-scrupulous mortgage brokers knowingly falsify borrowers’ incomes to qualify them for loans or at the very least, they apply lax standards for double-checking the stated figures on application forms. One of the issues that Home Capital had to deal with in 2015 was cutting its ties to 45 mortgage brokers who were accused of mortgage fraud. (Source: “Home Capital, Canadian Mortgage Lender, Ditches 45 Brokers Over False Info,” The Huffington Post, July 30, 2015.)

Far from being the bastion of unfiltered mortgage applications, Canada is still faring better than the U.S. was before its housing bubble burst. As of yet, there is still no mass prevalence of mortgages being granted to applicants with no official income to speak of, but there is a growing body of evidence to suggest this practice is slowly gaining traction in Canada as well. If proven to be true, it is only a matter of time before it brings down the whole unstable house of cards. (Source: “How mortgage fraud is thriving in Canada’s hot housing market,” The Globe & Mail, October 30, 2015.)

Perhaps more alarming is that CMHC, Canada’s government-managed mortgage insurer, has sounded the alarm in regards to red-hot overvaluations. A recent report, which focused on housing in the biggest Canadian markets, found that 11 of the 15 markets analyzed were overvalued. The biggest concerns identified were the high-octane condominium building regions of Toronto, Ottawa, and Montréal. (Source: “11 Housing Markets In Canada Are Overvalued: CMHC,” The Huffington Post, October 29, 2015.)

Indeed, indicators for overvaluation in the biggest cities, such as Toronto, Montréal, Edmonton, and Vancouver, have continued to increase, according to the report. Pricing levels have effectively disconnected from the realities of income levels and the average cost of living.

The dire economic consequences of a Canadian housing crash cannot be overstated, but the effects would be felt most by younger homeowners. If and when Canadian housing prices do decline, those in their 20s and 30s, and especially young families in this category, will stand to lose the most in terms of their overall net worth. If housing crashes beyond a certain point, many young people could end up owing more than their home is worth, which is a recipe for disaster.

But don’t take my word for it, because a sober look at the numbers reveals some startling conclusions. The group that is most vulnerable to a Canadian housing collapse is, of course, younger people, as they have not had ample time to build up their net worth.

For Canadians in their 30s, their debt-to-income ratio has nearly doubled since 1999 and has now skyrocketed to a new high of four to one. (Source: “Study: Changes in debt and assets of Canadian families, 1999 to 2012,” Statistics Canada, April 29, 2015.) This is the very highest ratio of any age group in the whole country.

Young families, burdened as they are by increased expenses, will feel the brunt of any significant Canadian housing market correction. Most alarmingly, a highly disproportionate amount of the economic fallout will hit younger families if the midpoint of the Bank of Canada’s projected housing market correction is reached.

Families where the average parental age is in the 30s will see their net worth drop by an average of $60,000, which corresponds to an average drop of 39%. (Source: “Are young homeowners doomed if housing prices drop?” CBC, November 16, 2015.) This would mean 10% of young families in this category will wake up to find that they now have a negative net worth and their hard-earned equity has disappeared overnight.

It doesn’t take an MBA to figure out that if you owe more than you own, you’re in big trouble.

Bottom Line on Canada’s Housing Market

There’s no use denying it, because it looks as if there is a Canadian housing market crash about to descend on the Great White North. The resulting fallout is likely to be a huge drag on Canada’s economic growth over the next several years.

The Canadian housing market has actually been one of the strongest sectors in the economy in recent years, but this could all come to a screeching halt sooner rather than later. Sadly, it was strong housing that, in part, helped Canada weather the worst of the fallout from the global financial crisis in 2008–2009, a time when the U.S. housing market crashed.

As things stand, it’s looking more and more likely that the Canadian housing crash will happen in 2016 and the resulting shockwaves in both the domestic and global economy could be devastating.

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