August 10, 2010, 5:00 am

Next Bubble To Collapse; The Canadian Housing Market?

by: The Financial Blogger    Category: Properties
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To burst or not to burst, that is the question! I recently had this conversation about the supposed housing bubble in Canada with my best friend (and partner in my online adventure). He was explaining that he believed that there was a housing bubble in Canada and that it wasn’t normal that the US housing market tumbled while ours barely bent its growth curve for a few months.

I must admit that he is a big follower of the US economy and while I think that Canada is in a enviable economic position for the next 10 years (solid banks, solid economy and full of natural resources).

In my opinion, we don’t have a housing bubble in Canada since our mortgage criteria are way stricter than our southern neighbours. Therefore, both the CHMC and Canadians banks are following severe debt servicing ratio guidelines to the dot (trust me, trying to qualify for a mortgage when you are 1% over the accepted TDSR is becoming a challenge these days!).

Another point to take into consideration, we never had 100% mortgages, interest only mortgages or 125% mortgages on our properties. In fact, the Canadian Government also forced new buyers to have at least 5% cash down and they can’t count on a 40 year amortization anymore. This is why I think our housing market is under control.

On the other hand, my friend is also strong willed and wanted to prove his point. This is why he forwarded me the following graph:

As you can see, this is the indicator of both the US and Canadian housing markets. They both start at 100 points and fluctuate according to the average price of houses over time. This means that when the index reaches 200 points, a house that used to sell for 100K back in 2000 will now sell for 200K.

The 2 indices are the most used references to demonstrate housing prices over time. They are well known and I can’t question the validity of the data.

What the graph shows is that the US market hit a summit back in 2006 at almost 210 points and then suffered a huge drop back to 140-150 points in 2010.

What concerns me about this graph is the Canadian Housing index. As you can see, we are dangerously approaching the 210 points mark as we are around 200 points right now.

While I still don’t believe that we will enter into housing down market, I am a bit concerned about this graph. One thing is for sure, I am pretty happy to have bought my house since I think I will live in it for a while. In fact, if you don’t expect to sell your house in the next 5 years, you don’t really have to care about a housing bubble that may burst, right?

What are your thoughts about the Canadian housing market?

What will happen when the housing market reaches the US peak? Will it tumble? Is our economy is built on the same housing bubble model as the US was?

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Comments

by: OttawaGuy | August 10th, 2010 (7:23 am)

TFB,

I respectfully disagree with your arguments about Canada’s mortgage rules protect it from such a fall.

While not the same as the US, Canada’s housing market was pushed by first-time home buyers with 5% down and 35 year amz. It will take a VERY long time for them to build the next 5% in equity especially with housing values decreasing… Here is an example of how a lot of people have been dooped in housing as a safe investment: http://www.financialpost.com/news/Getting+real+Bull+coming+Canada+housing/3369611/story.html

In addition, interest rates will rise significantly (relative to today and recent rates) in 5 years and these couples will be forced to renew at a much higher rate. Suddenly, 300K, 400K for a house with a 7% interest rate becomes unaffordable.

While the States relaxed the rules much more then Canada, we are not immune and Canada will face a much more gradual housing correction.

i.e. I think your business partner is spot on :) and thanks for the graph!

Wow, that is a very impressive chart that you posted, makes me worry quite a bit about where prices are headed. I read an article in Business Week that described Canadian Real Estate as the biggest bubble left in the world… quite scary stuff….

by: The Financial Blogger | August 10th, 2010 (8:41 am)

@ OttawaGuy,

I think that if people keep their job, the fact that they are losing equity because of house value won’t prevent them to keep their mortgage payment up to date. Therefore, I’m not sure why the housing market in Canada is about to collapse.

Interest rate will rise significantly… that is an assumption. Starting fall of 2009, financial journalists were claiming everywhere that the rates would climb up like crazy… nothing happen until June 2010. And then, we are not even sure if the Bank of Canada will rise them again in the upcoming months due to controlled inflation and unemployement rate back to 8%.

Definitely not what the journalists were saying. Trying to guess interest rate is like trying to guess who will win the Stanley Cup in 5 years… good luck ;-)

The graphs still concern me as it shows a similar story to the US’… but I’m an optimistic by nature ;-)

Thx for your comment!

@OttawaGuy – I obviously agree with your points:)

@TFB – While rates might not jump now or next month, they will in the next 1-3 years, would you agree on that? And when that happens, many will be stuck, not just here, but other places too… By the way, last week the Globe and Mail wrote about housing prices starting to decrease in some parts of Canada already!

Well, I agree and disagree. We had a correction in some areas, have a bubble in some, and nothing in others.
In reference to Ottawaguy’s Financial Post article as to how people are supposedly duped into buying real estate. First, the couple mentioned in the article bought the condo wrong. They bought it on speculating that the price would go up because they saw everybody else making $100k on their condos. If the property cash flowed positive and not the negative $700 per month payment its costing them now, it wouldn’t have mattered what the market prices did. They could hold on to it forever and not worry how they are going to pay for it. Now its eating them alive. Real estate is a long term investment. Their second house is much the same, based on speculation. For example, you can’t expect to buy house in a $200k neighbourhood for $200k and put $100k in renovations only to expect it to sell for $400k the month after purchase. It just doesn’t work that way and is not a good example of a bubble. These people were motivated by greed and fast cash not fundamentals. Hence why Flaherty changed the mortgage rules recently, to curb speculative buying, like soo many were doing in the Toronto condo market. These investors where buying up 5 to 10 units at a time with only 5% down on each only to sell them at a higher price once they are built. This partially causes a bubble. If one looks at RBC’s housing affordability report and specifically the summary table chart, it pretty much tells you which type of housing is in a bubble like state. For example, a standard two story in Vancouver demands 80.9% of persons income to be able to afford the house. You are left with less than 20% to pay for taxes and food and I think most us don’t pay less than 20% in income taxes alone. In contrast, for Ottawa it takes 41.3% of a persons income to afford the same house.
Hope this helps some to understand that depending on where you live you may or may not be in a bubble.

I should have also mentioned as well, that it is hard to say if people are going to keep thier jobs… And even if they do, it is difficult to believe that thier salary increases (if they even get any at all…..you being the exception :P ) will cover the increase in housing payment they’ll need when it comes time to renew. Insurance has also increased in parts of our country, and lets not forget reno’s sitting on peoples LOCs or even worse credit cards…

And the cup will be in Ottawa in 5 years! :D :D GO SENS GO!

Great point TK. The example is extreme but I’ve heard the same reasoning from friends and colleagues that real estate only goes up and you can’t go wrong. I would be interested to know what the % was from 15-10-5 years ago of income to housing debt. Would it show a bubble trend?

Long-term, I can’t argue. If you’re buying a place you can afford and not put your entire net worth into a down payment, to be your home for 20-30 years. Then sure it is not a bubble for you. But most Canadians, from what I’ve read, are riddled with debt.

Even rereading my posts I sound like a real negative-nancy lol but I am still concerned about our countries economy. Especially when we toy with the average Canadian’s biggest and most emotional asset.

Here in Calgary, it’s definitely ready to burst. Properties aren’t moving, but a lot of sellers are unwilling to lower their prices. I have seen some properties drop 100K off their asking price though, so it may already be starting.

With real wages stagnating, and comparatively cheap rent, I think housing prices will stagnate for a few years.

by: The Financial Blogger | August 10th, 2010 (12:15 pm)

@ OttawaGuy,
as long as you are not taking for the Leafs, I’m alright with your pick for the Stanley Cup ;-)

Unfortunately, people think that they can make easy money with real estate (as mentioned by TK). The truth is that any investment type needs to be carefully analyzed before making any decision.

Housing market usually follow the inflation over a long time period so there is not much to make out of it…

However, I would be quite surprised to see the housing market dropping by 20-30% in a span of a year like the US did… we’ll see!

“In fact, the Canadian Government also forced new buyers to have at least 5% cash down and they can’t count on a 40 year amortization anymore. ”

5% is peanuts, and for a good while you could amortize over 40 years. Plus banks were happy to give you that 5% back with cash intensives and by opening low interest lines of credit. This is especially troubling considering the incentive to buy with rock-bottom interest rates.

Don’t forget banks don’t have most of the mortgages as liabilities on their book. CHMC (a crown corp.) has backed most of the mortgages banks have given out should they ever go under. Banks aren’t on the hook when this bubble comes, taxpayers are.

Will we see a country wide drop of 20-30% in housing prices, i think not. The only way that would happen is if we lost a lot of jobs (hence what happen in the US) and the only reason that would happen is if the central bank raises the interest rate too fast, which would intern create a bigger demand for the candaian dollar and hence see a rise in the dollar vs the USD. If that happens then a lot people would loose there jobs as we would not be competative with our neighbors down south. It would be great for Albertan though as the US still needs oil and are willing to pay for it. But MFG’d goods they can go shopping for. Thats why the bank of canada has to be very cautious as to when and how much to raise rates. Tough place to be in if you’re the governor of the bank of canada.

Cool picture, Mike.

I doubt that prices can continue to go up. At best, we can see them sliding sideways or going upwards slowly with inflation. Nothing else makes sense unless credit becomes even cheaper (unlikely), or incomes catch up.

Sorry Mike, I gotta go with your business partner on this one. The other commenters did a nice job of outlining why.

And I think that we will see markets that fall over 30%. Vancouver and Toronto come to mind. I wouldn’t be surprised to see Calgary fall that much either.

The worst part of negative equity is that you lose options. Because you’re the man Mike, let’s say a certain bank wants you to move out west for a great opportunity. However, all of your net worth is tied up in your house, which has dropped to the point where you owe more than what it’s worth. You want to sell, but the bank says you can’t unless you come up with the difference.

That situation might not happen to you Mike, but it could happen to thousands of home owners. And while it wouldn’t cause a slowdown, it would keep one going.

In the greater Vancouver area, housing value double 2 years ago in the span of 3 years. It then continued to climb and it only started going a little over this past year. It was ridiculous though, houses wouldn’t last more than 2 weeks in the market. This is more like normal at the moment in terms of time on market.

It’s not because it’s lower than last year that the bubble is going to burst though … because it’s still a lot higher than 7 years ago and I don’t see it reaching those prices with all the people wanting to buy … Mortgage rates will have to go up a fair bit to put the squeeze. Will they give up the pricey iPhone data plan over the mortgage is my question :)

The new developments aren’t really selling at a cheaper price and I tend to look at that to see how it fares. There are about 4 in development not far from where I live and it’s selling well.

Many good points here. I don’t disagree that many people will be able to continue to make the monthly payments. However, a decline in prices will be caused by a combination of both psychology and the “marginal” homeowners who are forced to sell.

With the price of real estate beyond what many families can afford, it is inevitable that there will be a decline. At a certain level, people just cannot afford to pay ever increasing prices. Then a few homeowners forced to sell for various reasons (job loss, relocation, etc.), possibly accept a lower offer, establishing the new lower-level of comparable prices.

Then psychology kicks in, seeing some small price declines, more people try to sell before the market declines even more. Seeing declining prices, buyers will hold out in.

That’s my prediction, unfortunately, the seemingly unlimited number of buyers out there has proven me wrong for several years!

Gonna be interesting with your gov’t raising rates and that chart looking all frothy!

We shall see!

by: Matt Tucker | August 11th, 2010 (7:08 am)

We also shouldn’t forget that we will probably have more and more people retire over the next 5 years, and the effect that will have as well, especially if a large number of them want to downsize and put their houses on the market, and there isn’t enough buyers interested in buying those houses.That could also start pushing prices down as well.

[...] The Financial Blogger thinks that the Canadian Housing Market will be the next bubble to collapse. [...]

Interesting time period you have chosen for the graph and also shows that if you choose an appropriate time period you can ‘prove’ pretty much anything you want to prove.

The Economist magazine regularly surveys international real estate prices and uses a flexible graph that can go back several decades if one opts to look that far back. For anyone who chooses a longer time period on their system, it is obvious that Canadian house prices have lagged pretty much every other major market in the world over any longer time period and are very reasonably prices compared to almost anywhere else (certain markets in Canada like Vancouver possibly excepted). My house here in the southern interior of BC is valued at far less than the equivalent where I used to live in Australia. Ditto in New Zealand prior to that. Ditto in UK where my wife is from.

Further, knowing a fair bit about housing in all those markets and the USA as well, I can assure your readers that policies that have created bubbles in those countries simply do not exist here and will never exist here unless policies change radically in Canada.

Bubble? What bubble?

I’ve been saying for a number of years that we are headed toward disaster in our housing market. A bust is definitely within our sight. Any trip in a car to the outskirts of an Ontario town will provide you with rows and rows of duplicate houses and urban sprawl. We only have 33 million people, don’t we?

:)

[...] Financial Blogger, channeling Garth Turner predicts that the Canadian housing market is the next bubble to pop. Mike, didn’t you just buy a new [...]

[...] Financial Blogger wonders about the Next Bubble to Collapse; The Canadian Housing Market. My personal opinion on will we collapse? No.  Market correction? Hell YES!  How big? Damn good [...]

The rules are better now, but only 6 months ago they were pretty lax, and its already too late. Every single person in Canada rushed to buy a house when interest rates went to 0%, thinking they could lock in. Get ready for the collapse when rates go to 6-7%.

@TFB – We bought our first home back in ’03 and have seen the housing market basically double, with the peak being last Fall. Since then the real estate market has slowed to a crawl here in Alberta. I agree that if you can keep your job, most Canadians will be able to weather the storm if housing prices fall…even if interest rates rise 3-4%

We’ve had a new edition to the family and need to upgrade our housing in the next year. I’m very curious as to what will happen with the real estate market and interest rates.

[...] stock market when it is down @ PersonalDividends -ETF does not mean index @ Wheredoesallmymoneygo -Next bubble to collapse: The Canadian Housing market? @ TheFinancialBlogger -Contango: A good reason to avoid commodities @ CanadianCapitalist -Why the [...]

I totally agree with the guy who had the U.S. graph. How on earth can anyone think that Vancouver Housing prices will remain stable under the guise that “We are Vancouver”. Isn’t that what the prominent cities in the US (LA, Miami, Las Vegas to name a few) said. For what it costs to buy a house in Vancouver, you can now buy the entire Condo Complex in many US cities. C’mon Vancouver…..GET REAL!!!

Well, I agree with point that housing pricing is stagnating and on the top of it sellers really don’t like to hear about lower prices. Banks can offer a mortgage and if you have a constant income you can obtain a solid property to live in or to sell it again. The housing market will go down but it probably hardly reaches 20% in 2 years time…

[...] The Financial Blogger wonders if the Canadian housing market is in a bubble that’s about to burst. [...]

[...] Housing bubble in Canada? [...]

by: Better be scared | September 13th, 2010 (7:30 pm)

Anyone who isn’t afraid must be too young to remember the real estate market in the 80′s and 90′s. Before interest rates started lowering to historically unprecedented lows over the past 7 years, the average interest rate in Canada over the previous 50 years on mortgages was about 12% for a 1 year term. I bought a property when one year rates were 19% and another at 14%. When rates came down to 11% in early 1992, it was a joy and behold feeling in Canada. Historically, banks couldn’t lend for more than 25 yr. amortization. Do the math. Get out your interest and amortization tables. Anyone taking a mortgage now shouldn’ t take an amortization greater than 15% .That’s a warning from someone with experience. This is the scariest I

by: Better be scared | September 13th, 2010 (7:31 pm)

Anyone who isn’t afraid must be too young to remember the real estate market in the 80′s and 90′s. Before interest rates started lowering to historically unprecedented lows over the past 7 years, the average interest rate in Canada over the previous 50 years on mortgages was about 12% for a 1 year term. I bought a property when one year rates were 19% and another at 14%. When rates came down to 11% in early 1992, it was a joy and behold feeling in Canada. Historically, banks couldn’t lend for more than 25 yr. amortization. Do the math. Get out your interest and amortization tables. Anyone taking a mortgage now shouldn’ t take an amortization greater than 15% .That’s a warning from someone with experience. This is the scariest time I’ve ever seen.

You should be scared about housing prices in Canada, if you’re not !
I bought a property in 1980 when interest rates were 19% for one yr. term ( 22% for 5 yr. term) and another when they were 14%. When rates went down in Canada in the early nineties to around 11%, it was joy and celebration in Canada!.Prior to this extremely low interest rate environment over the past few years
( which almost alone has fuelled high housing values) the average mortgage interest rate over the previous 50 years was 12%.
So beware, prices are going down now in direct proportion to interest rates going up. Listen to experienced people.

by: The Financial Blogger | September 14th, 2010 (12:11 pm)

@Jay,

what tell you that interest rate will go back up to 10%? Is Nortel going back up to $120?

The economic conditions 30 years are not the same as today. It’s like people talking about the Great Depression back in 2008… still waiting for my food coupons ;-)

Seriously, I don’t see why interest rate would jump all of a sudden.

Banks were also paying 10% in those days. My dad often reminds me how easy it was to invest in those days because you could get guaranteed investment in the 10% range.

I don’t believe interest rates would go that far up without paying higher interest for savings.

If all you have is debt, than trouble looms … but if you manage to save some money as you should then there is a certain balance.

by: The Financial Blogger | September 15th, 2010 (3:49 am)

@Passive Income Earner,

What is interesting about your dad’s story is that everybody tend to forget a very important point: inflation was skyrocketing at that time too!

Therefore, if you are making 10% on your CD, pay 3% in taxes (I think taxes were lower back then), you have 7% net. Add a 5-6% inflation rate on it and you are not making much than what you can make today ;-) It’s all a matter of perception!

[...] I rarely do this, in fact, I never write a second post during the day unless there is a modification in the interest rate. But today, I just read an article about the Canadian housing market and I was thinking of all your reaction towards my article on the (possible) Canadian Housing Market Bubble. [...]

@ the financial blogger…” while I pay interest only on my mortgage, I think I will be able to build an interesting investment account”.
Some principles in money management never change.First priority should be to get your home paid for first and as soon as possible. Get the roof over your head paid off. While interest rates are low ( and you may have paid too much for your house) now is the time to pay off a massive amount of principle, so that when interest rates go up, you won’t have to go into foreclosure. You will have a manageable principle balance where you can afford the higher interest rate. Aim for an amortization ( paid off) period of 12 to 15 years max. ( or less if you can afford it). The government is in the process of making ‘ interest-only ‘ mortgages illegal, as they are extremely risky and against the best interests of consumers.
Don’t use mortgage equity( or what should be money going toward principle) for other potential investements. That strategy has bankrupted many people. When you have paid off you house, you will save enormous sums of interest payments to the bank. Also you have peace of mind and security.

by: The Financial Blogger | September 15th, 2010 (12:44 pm)

@ Jay,

I don’t really mind if I paid too much for my house as if the value drops by 20%, this will also means that I can buy any other house with a 20% rebate. In the end, you never make money with your house until the day that you sell it to go to an appartment ;-).

I am not affraid of seeing interest rate going back up to 10% as I don’t think it will happen. I agree with you that the situation was tough back in the 80′s but it doesn’t mean it will happen again. In the same line of thoughts, what if we are about to live the Japaneese reality for the next 15 years? (no growth and low interest rates).

If interest rates goes up, this will mean that the economy is on fire. if the economy is on fire, this means that my investment will also be in good shape. Therefore, I can sell them to pay off my mortgage at that time. This is why I am not too worried. I may be wrong, but I am willing to take the guess.

Money saved is money earned. If your mortgage is paid off, your main financial worries are over. You can consider doing what you really like to do in life. Home values do not always go up ( above inflation.) Also, re: interest rates, before the ’80′s, the rates were averaging 11 % for the past 50 years. That is the norm. Right now there are unprecedented low interest rates. This is the lowest possible bottom of the curve.
The home owners who made a lot of money in real estate bought when interest rates were high and sold when they were low.( because the property values have skyrocketed over the past several years.) If you buy when interest rates are low and sell when they are high, the opposite will be happen. Property values will go down.

by: The Financial Blogger | September 16th, 2010 (11:38 am)

@Jay,

I agree with you that house value doesn’t always go up. In fact, I really don’t think it should even be seen as an investment (for the main residence).

Home owners who made money didn’t really made money as they had to buy another inflated property. The opposite situation happens as well.

If my house (I paid 332K) was to lose 32K in value tomorrow, all the other house of the same market would lose the same amount (in percentage). Therefore, you are not really losing money, just your net worth that is decreasing…

If you had to sell your house in order to move to another job location, due to job loss or for any other reason, and the value was down 32K, the remaining cash value you take with you will be decreased substantially especially when substracting the real estate commission.
Money lost is money lost, whether it’s stock value or house value going down.Some who sell may end up owing money to the bank when they sell, as huge numbers do now in the US.
Paying off one’s mortgage as quickly as possible has always been sage advice which has held many generations in good stead.
Certainly,one should aim to have it paid off by retirement ! Agree?

by: The Financial Blogger | September 18th, 2010 (6:41 pm)

@ Jay,

The only thing is that if my house is down 32K and I sell my house to move into another one the same size, I’ll pay 32k less as well. Therefore, I won’t be losing money. Main residence is not an investment, it’s an expense as any other.

I sold my second house with a 75K profit… but I just reinvested it into my next house that I had to pay at a higher price as well.. sum zero game.

My goal is to have my mortgage paid off by retirement, I agree that it’s a huge burden to have an outstanding mortgage at the age of 60-65!

I have to agree with Ottowaguy, and I also think that even if our interest rates go up a bit, people have to be qualifying at a higher rate to receive the extremely low variable rates. So they are safe at least as much to generally 5.41%. But yes real estate is a long term investment. It should be thought of as a place to live. I think because of the housing boom a few years ago people did get really greedy to thinking they can make a quick flip and earn a bunch of money. This throws the market off. Housing should definitely only be looked at as a long term investment. I truly believe there is only so much land, and population is always growing. In the long run, prices should always be going up. But when we watch closely of course we get scared. And I do have to say thank god for the Canadian Mortgage brokers and for our banks, a 100% loan is just crazy.

Whoops I meant to say I agree with The Financial Blogger. I wrote the wrong person sorry.

Realestate in a sense is a game of apples for apples. You can sell high, but you will buy high. You sell low, you get into a lower market. When you stay in the game you cant really win.

What concerns me about this chart is the Canadian covering directory. As you can see, we are hazardously forthcoming the 210 points mark as we are around 200 points right now.”

[...] I don’t believe in a Canadian Housing Bubble. We might see a slide in a few overheated markets such as Vancouver, Calgary and Toronto, but in [...]

When wages increase 5% the price of living increases 15%. The housing market follows this same trend for the most part.. Any idiot knows the housing market will crash. It’s guranteed.

[...] Financial Blogger looks at the Canadian housing market … is there a [...]

It doesn’t seem to me to matter much that most people, even when interest rates rise, will still be able to make their mortgage payments. All it takes is a few percent that can’t make the payments to start a collapse (like in the US). That is, a few percent that need to sell, few buyers because the houses are very expensive already and values are expected to decline. Then prices start to fall, and the more people that panic because there upside down, the more prices fall. It’s an unstable situation.

@Sean

Thanks for bumping the thread. It was interesting to read the crystal ball theories from 2 years ago :) None of it happened.

Interestingly enough, after 2 years, interest rates are still low but we have stricter mortgage rules for new home buyers. Prices are adjusting in the Greater Vancouver Area but they aren’t crashing. New developments have lower prices but they don’t drop much, builders add better quality items to the houses to entice buyers. Prices had to adjust simply because it was pricing out too many buyers.

I think it’s the first year that houses are selling below their city assessment in some regions. It definitely highlights an adjustment and there are many properties in the markets.

In my view, the fear effect you highlight is the only potential catalyst that can create a worst situation. Defaults are really low and since new buyers have stricter rules, previous new buyers have time to adjust. Retired families in my neighbourhood have not even moved out to cash out at the peak.

I would favor an increase in rates at any time just to show that rates will increase. Unfortunately, it has an impact on currency and consequently importing which translates into job losses … It is a very interesting situation we are in.

I’d love to hear some intuitions 2 years later.