FINANCIAL ICEBERG

Always consider hidden risks

​

BLOG

Canadian Mega Housing Bubble

( From MacroBusiness, CREA,​ Canada s Housing Bubble, The Atlantic, Teranet )

Household Incomes and House prices



​​Housing activity in Canada is at a near record share of GDP, and there are indications of overbuilding and overvaluation in some segments of the housing market. Reflecting the strength in spending relative to income, Canada’s current account has been in deficit for the past four years.



These trends are not sustainable… Something needs to take the place of increasingly leveraged household spending or economic growth in Canada will slow…



The strength in housing activity has also been reflected in rising house prices. Over the past decade, the price of the average home has risen from 3.5 times disposable income to more than 5 times. ( see graph below )

The situation

​

For the past few years having watched with interest the Canadian housing market’s continued rise in value. Whereas most other housing markets, including Australia’s, have taken a breather, Canada’s has powered-on, rising in value by 26% nationally since its April 2009 low, according to the Teranet house price index (see next chart).



But ​​there are tentative signs that Canada’s housing market may finally have peaked, with the Teranet national index recording four consecutive monthly falls (down -1.3% since August 2012), which is the longest consecutive number of monthly falls since the 2008 recession.



​​

Mortgages Rates​

​

The surge in Canadian home values has been fueled by a big reduction in mortgage rates. The official cash rate in Canada currently sits at just 1%, with average five year mortgage rates sitting at 60-year lows of just 4.15%, according to the Bank of Canada ( see graph below ).

​​

The Factors Behind that Mega Housing Bubble



​​The Canadian Economy

​

​ The Canadian economy emerged unscathed from the global downturn in 2008-2009; mainly on account of its vibrant financial system, resilient corporate sector, stable housing market and prudent Fiscal-Monetary policies. ( See graph below )





Canada Real gross domestic product

CMHC Easy Financial Terms



The Canadian Mortgage Housing Corp has been extremely easy on conditions for buying a new home. In 2007, you were avle to buy a house with 100% financing and amortization up to 40 years...





​​​​​

The Valuations

Canadian household debt

​

​Canadian household debt, too, is at all-time highs, having recently surpassed the United Kingdom and the United States ( see graph below ).

Today, the balance sheets of households are stretched. After 11 consecutive years with household outlays exceeding disposable income, household debt burdens have increased substantially. Household debt as a percentage of disposable income has risen by almost 60 percentage points to 165 per cent today, and Canadians are now more indebted than the Americans or the British.

House Prices to Rental Valuation​

​

And the house price-to-rent ratio has increased from 1.3 to 2.3 ( see graph below ). Both of these measures are now well above their historical averages.

​​

House Prices to Rental Valuation​ - Comparison

​

​The distinction between higher prices and bubbly prices isn't as subjective as it might sound. Like any other financial asset, there should be a fairly steady relationship between the price of housing and the stream of income -- rent -- it produces. Should be. The chart below, from The Economist, looks at the price-to-rent ratios across different countries, and measures how under-or-overvalued housing is, with negative numbers corresponding to the former and positive ones to the latter.

The Concerns



Canadian economy is slowing quickly

​

The slowdown in the Canadian economy in the second half of 2012 was more pronounced than the Bank of Canada had anticipated at the time of the October Report. In particular, exports and business fixed investment have been weaker, reflecting both foreign and domestic developments. While global tail risks have diminished, foreign demand has been more subdued than expected. The Bank of Canada has also become increasingly worried about the level of household debt and the unbalanced nature of Canada’s economy.

​​​​​

CMHC New Financing Rules

​

Seemingly worried about the frothiness of the housing market, Canada’s Finance Minister, Jim Flaherty, last week signalled that he would like Canadian house prices to come down “a bit” from current levels.



Indeed, in July 2012, Flaherty moved to cool the Canadian housing market by capping the maximum mortgage amortisation period at 25 years for people with deposits of less than 20%. The impact of this move to date has been somewhat negative, with house sales falling by 17% in December on a year-on-year basis and prices down marginally since the new rules were introduced.



That said, the rule change represents the fourth time in as many years that Flaherty has changed the mortgage rules in order to make it harder to get a mortgage, and on each previous occassion Canadian home prices took an immediate hit before rebounding strongly thanks to low interest rates.

​​

Sales of Existing Sales



​​

Housing activity has also moderated recently. Sales of existing houses have softened, falling below their 10-year average in the third quarter. More recently, housing starts have also fallen from very high levels, but even with this decline, housing construction remains above demographic demand…



​​According to statistics released today by The Canadian Real Estate Association (CREA), national home sales activity was little changed on a month-over-month basis in December 2012, holding it in line with levels reported in August when demand first geared down in the wake of tighter mortgage lending rules.



Actual (not seasonally adjusted) activity came in 17.4 per cent below December 2011 levels. Four of every five local markets posted a year-over-year declines in sales activity in December. ( See graph below )





Conclusion

​

These are encouraging signs of a stabilization of household imbalances and a more sustainable housing market. But after a decade of buildup, it is too early to be sure.



It looks to me like the Canadian housing market is facing some sort of correction. It’s just a question of whether it will unwind gradually or in a disorderly manner.

​

​​​Changing market conditions have triggered a shift in the Canadian homebuyer mix and mindset, a fact identified and confirmed by the RE/MAX Canadian Homebuying Trends Survey 2013-2014.

​

​​Canada is quietly trying to deflate its bubble without any eye-catching headlines. And that means keeping interest rates low while making mortgages harder to get.



But by keeping rates where they are and slowly tightening mortgage requirements, Canada hopes to engineer a more gradual price decline that won't set off a vicious circle.

​

Though we Canadians like to convince ourselves that it's different here and house prices will rise incessantly despite overwhelming evidence to the contrary, history remind us that this belief is as irrational as it is dangerous.



Canada is not immune of an housing slowdown...