The hot housing market in Canada seems all too familiar. More mortgages without down payments, rising home costs without matching rises in income, and an extremely high ratio of house prices to rents. It all spells a bubble waiting to burst.
But even so, conflicting reports exist about the state of affairs to the north. So I contacted David Madani, Canada economist at Capital Economics.
“We think it is a bubble. All the warnings signs are flashing,” he said, citing high house prices relative to incomes and rents, the upswing in homeownership rates, excessive household debt and overbuilding.
“The historically large gap that now exists between house prices and income — and rents — indicates to us that a house price correction is unavoidable at some point in the not-too-distant future; we seriously doubt that incomes and rents will ‘catch up’ to house prices,” he said. “The macroeconomic trigger for a housing price correction is like asking what’s a rational trigger for an irrational market.”
Average house prices are now 12 times personal income levels, which more than tops the 9.7 peak in the last Canadian housing bubble in the 1980s. Because of this, household debt as a percent of income is creeping closer and closer to the level it was before the U.S.’s bubble burst and right now sits at 153%.
Does anyone remember when Canadian Prime Minister Stephan Harper boasted that “Canada was not part of the problem” in 2010 after the U.S. housing market started to at least inch back to sanity? Well, it seems to be becoming a problem now.
Houses in Canada are stunningly overvalued (by about 70%), and are likely to suffer a serious correction in the way of 10% to 15% as foreign investors flock and as the overbuilt condo market catches up to them, reports TD Bank. TD also predicted that the country would reach a 160% debt-to-income ratio by the end of the year, the same ratio that pushed the U.S. and U.K. housing markets into correction.
Running at more than 13 years, this is the longest housing bubble in the world and probably why a lot of people keep saying, “No, this is different.” Really, it’s not.
While housing prices rise and builders keep building up there, the economy is slowing. The Canadian Employment Quality Index indicated that the Canadian economy slowed to a stubborn halt in the second half of 2011, forcing self employment to go up (a bad thing, since those self employed in Canada tend to make 10% to 15% less than they would otherwise), and public-sector employment to stall.
While the report said a housing crisis was unlikely (I disagree), they still said it was bound to stall, and that even a soft stall would mean bad things.
“…even if house prices land softly, the impact on the economy in general, and construction jobs in particular, will be far from gentle,” it said. “Real estate has been an important engine of economic activity, with the number of high quality construction jobs rising by 3.5% in 2011. That is more than double the pace of employment gains seen in the economy as a whole. That momentum will be lost when the housing market levels off.”
But, there is good news. The Canadian bubble is unlikely to burst as loudly as the American bubble, largely because there aren’t nearly as many mortgage benefits up there. Canadians, for instance, can’t get out of mortgages — even in the case of foreclosure. This makes it less likely that they’ll walk away from their homes. Also, mortgages are not tax deductible there, which reduces the incentive to apply for a mortgage when it may not be in your best interest.
But while it might burst with a bang instead of an earth-shattering explosion, our friends from the North are certainly in for a shock. And that will be pretty bad, eh? (Sorry, I couldn’t resist).