Sturdy as a house of cards? A look at Canada’s property boom

First-time buyers are screwed. Many young families who’ve bit the bullet on oversized mortgages are dangerously vulnerable in the event of a downturn, while the whole creaking apparatus of Canada’s gilded housing market could be overpriced by nearly a third. At least that’s what the Bank of Canada now says.

Boomers, meanwhile, counting on their suburban bungalows to double as gold mines that will shower them with cash in retirement maybe want to sell before the house of cards collapses.

That’s become the well-established — and rightfully alarming – narrative painted by Canada’s housing market bears, who’ve been saying for the last few years, as prices have raced higher, that a crash looms.

On the other side of the fence though are experts who say the market is fine, supported by demographic fundamentals, low interest rates (that are drifting lower), and stable employment levels churning out enough income to keep mortgage payments current.

“Despite calls for a significant decline in Canadian housing activity, the overall market continues to show remarkable resilience,” economists at TD Bank, for example, said on Feb. 12. “Conditions are expected to remain stable over the next few years.”

Canadian home prices appreciated a “sturdy” seven per cent nationally last year, TD said, or roughly double the pace of income growth. Gains were even higher in Vancouver, Toronto and Calgary.

“These increases portray a picture of housing tranquility,” commentary from noted housing pessimists at Capital Economics said the same day. But, “some regions are likely at the beginning of what could prove to be significant market corrections.”

Time will inevitably tell whose version of reality holds, but as the multibillion-dollar real estate industry gears up for another spring selling season, there are numerous warning signs that both buyers and sellers should pay close attention to.

Price boom

Calgary – and Alberta as a whole— appears poised to be one such market entering correction. But even now, if you’ve been in the market for awhile, you’ve made a big return.

Last month, the House Price Index (HPI) benchmark price for a residential property in Canada’s energy capital reached $454,200. That’s a jump of 109 per cent compared to February 2005, when $215,400 got you a mid-market single family home. Meanwhile, home prices in Vancouver and Toronto — the country’s two most expensive markets — have bloated 68 per cent and 71 per cent over that time, respectively, to $641,600 and $522,200 (benchmark price, across all housing types).

Incomes haven’t come close to keeping pace. And filling the void has been an ocean of low-interest debt.

Household debt has grown 80 per cent since 2005, to $1.8 trillion, most of it — $1.2 trillion — in mortgage loans. The surge in leverage has pushed the indebtedness of the Canadian public to record highs in the process. While the yawning gulf between home values and incomes has now left a sizable chunk of would-be homebuyers with too little saved for a down payment, or at least second thoughts about putting their chips down.

“That’s the big quandary. On one hand, mortgage rates will never be lower, on the other hand the price of your average house is so many multiples above average incomes, it’s just so prohibitive for a buyer getting into the market,” said John Andrew, a professor at Queen’s University and expert on housing. “But we were saying the same thing three years ago.”

Warning grads

Andrew has started warning his business graduates to carefully weigh the decision to take the plunge – even in markets so far unaffected by falling oil prices, like Toronto, as well as on relatively cheaper housing like condos.

MORE: Unsold condos pile up in Toronto, hit 21-year high

“Let a landlord take the risk,” Andrew said. “I don’t particularly like the condo market in downtown Toronto right now. Personally, that’s a risk level I wouldn’t be comfortable with. And I would probably say that for Vancouver.”

GTA versus Chicago

To get a sense of how expensive Canadian homes have gotten, prospective home buyers could take a visit to Georgetown, Ont., a community of 40,000 that sits on the outer boundary of the Greater Toronto Area. The commute to Toronto is long, but even here, homes don’t come cheap.

“Ultimately, like anywhere, it’s location, location, location,” local Re/Max agent Darren Morris said.

Morris’ team successfully sold this month a two-storey home on Princess Anne Drive, a well-designed 3,000 square-foot brick house with four bedrooms and three bathrooms; the idyllic home for the idyllic average Canadian family.

The price: $660,000. Based on a five-year mortgage with a fixed interest rate of 3.09 per cent, the cost would be a few bucks shy of $600. Each week.

“In comparison to prices in Mississauga, Toronto or Etobicoke, we’re still pretty affordable,” Morris said.

Contrast that listing with properties situated about an hour outside of a comparable North American centre — say, Chicago. Experts suggest (which online listings back up) that a young family could reasonably expect to find a comparable home to the one Morris sold for about half the cost.

And Chicago, which went through a price correction in 2008, isn’t the only major American centre where home prices are meaningfully lower than what buyers are confronting near Toronto.

“This is even the case in New York, outside of Manhattan,” said Diana Petramala, a housing economist at TD Bank. “If you compare the suburbs around Toronto, they’re far more expensive than suburbs that surround other major urban areas. It’s much more difficult to find affordable properties here.”

‘Old peak’

You could say it’s a Toronto thing. But it’s not.

Pricey real estate relative to incomes has become endemic across the country. The old rule of thumb when taking out a home loan was that it shouldn’t exceed three times the amount of your annual household income. Anything above that level, you risk losing your shirt if you’re hit with a financial shock, such as a job loss.

But in Canada, no one’s contained themselves to within that threshold in years. The average “multiple” of home price-versus-average household income has hit 5.6 times, according to TD Bank (see chart). In British Columbia and the GTA, multiples are dizzying, fueled in part by wealthy foreign investment.

“Canadian housing prices are almost double U.S. housing prices,” said Hilliard MacBeth, a portfolio manager from Richardson GMP in Edmonton. “What makes us think we can afford double?”

MacBeth, another notable Canadian housing market bear, suggests the multiples Canadian homebuyers are paying on bloated home loans are well in excess of any housing bubble in Canada before now. He said that during previous housing busts in the late 1970s and late ’80s, borrowers hit “the old peak” of about 3.5 times incomes.

“This is a much, much bigger bubble,” said MacBeth, who believes home values could crater by 50 per cent.

But TD’s Petramala said this time is different. “What’s important here is that interest rates have come down, so historical comparisons might not hold in this environment because rates are so low. And we don’t expect them to return to historical levels in the near future.”

Rate risk

Come mortgage renewal time, first-time buyers who have jumped into the market in recent years are hoping Petramala is right.

“I think their big risk isn’t so much a correction, because they’re already in the market. Their risk is a mortgage rate risk,” Queen’s professor Andrew said.

“Let’s say they took out a mortgage two years ago. In three years, that mortgage is going to come up for renewal. What most people do is borrow as much as they can, buy as much home as they can possibly afford. And for most of us, income growth isn’t outstripping inflation, so three years from now, what if that mortgage rate isn’t three or four per cent, but five or six?” he asked.

“Will they be able to make those mortgage payments – will it take every cent that they’ve got and be a source of tremendous stress for them? That’s really where the risk for them lies.”

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Western slide

Alberta is providing buyers and sellers in other markets a glimpse of how quickly conditions can sour as crashing oil prices send a deep chill through what has been Canada’s hottest housing market.

Sales in Calgary crumbled 34 per cent last month, while average prices fell 4.3 per cent compared to February a year ago. New listings have surged 107 per cent, suggesting much more downward pressure on home values awaits as power shifts into the hands of increasingly nervous buyers.

Other markets where oil and energy prices that have drawn in workers and housing investment are now falling as well, such as Saskatchewan and Newfoundland (see Regina in the chart above).

“Prices appear to be on track to fall by as much as 10 per cent in Calgary, Edmonton and St. John’s over 2015 and 2016,” TD said this month.

Hilliard has written about investment follies previously in his 1999 book Investment Traps and How to Avoid Them. In it, he lays out the case of what he calls the “buy-high trap” that seduced pensioners and others to buy into the dot-com stock market mania that eventually popped a couple years later.

“The funny thing about bubbles is that the timing is the unknown. In 1999, there were warnings several years before the dot-com bubble burst,” Hilliard said. “But while you were in the middle of it, it just kept going and going and going.”