The Canadian Mortgage and Housing Corporation’s (CMHC) latest report warns of “problematic conditions” in the country’s largest housing markets.
Overall, there is “strong evidence of overvaluation across Canada,” the report states, with Canada’s hottest housing markets leading the pack.
“In Toronto and Vancouver, this is due to the combination of price acceleration and overvaluation.”
The federal agency in charge of supervising Canada’s banks released a revised stress test guideline Tuesday, suggesting banks test if they could weather a 50 per cent drop in real estate values in Vancouver, a 40 per cent drop in Toronto and 30 per cent fallout elsewhere in Canada.
The warnings of an out of control housing market keep coming.
But what would a real estate collapse look like in Canada?
The ripple effect of a real estate collapse
There is certainly a chance prices could drop dramatically, said University of British Columbia professor Thomas Davidoff. He said a 50 per cent drop in Vancouver real estate values would be “catastrophic.”
“Now, by no means do I think that is a likely scenario.”
If a bubble were to burst, the real estate market would slow to a crawl.
“You’d probably see very little transaction volume,” said Davidoff. “People would be locked into their homes and their mortgages.”
There would be winners and losers. Those in no hurry to sell can sit tight and hope prices rebound. And those looking to buy could be in for a great deal.
But anyone who is having trouble covering their mortgage could be in real hot water, if their house loan ends up eclipsing their property’s readjusted worth.
“They’re underwater. And so they can’t sell their home or they’d have to bring money to the closing or they’d have to endure a credit hit. They banks have recourse,” Davidoff said.
“The interesting question to me is whether banks really would pursue recourse … Politically, would a small number of Canadian lenders really get into the business of you know, chasing people down and breaking kneecaps when they don’t pay off their loan?”
If people can’t make payments, they may have to give their property back to the bank, which then sell the properties at a loss, potentially flooding the market.
“It’s a potentially very, very ugly scenario.”
A spike in interest rates could lead to “catastrophe” all around, said Davidoff.
A lot of people make money off real estate, directly and indirectly. Real estate agents would make less, as would lawyers drawing up the sales paperwork.
Unemployment for those in the building industry could be widespread, from contractors and labourers to security guards and cleaners.
Mortgage lenders won’t be making as much money, leading to fewer profits and bonuses for employees. And less money in the bank means decreased spending elsewhere.
Provinces (and some cities, such as Toronto) would take a hit from a loss of revenue due to property transfer taxes drying up.
While many loans are insured, those that aren’t could easily spell trouble for lenders.
“The financial sector, they’d certainly be making less money, might get into losses and it would be very, very frightening,” said Davidoff.
The province of British Columbia is attempting to pump the brakes on foreign ownership, long suspected of driving up prices in Canada’s hottest housing market, by imposing a 15 per cent tax on foreign nationals buying property in Metro Vancouver.
Yet Prime Minister Justin Trudeau has warned that restricting foreign investment is risky.
Ultimately, no one can predict the future, but Canadians should be encouraged that banks do stress tests to ensure they could survive a real estate collapse, Davidoff said.
The test is for lenders “to determine whether they are in sound financial condition,” said Office of the Superintendent of Financial Institutions (OSFI) spokesperson Annik Faucher in an email to Global News.
“We have provided some stress testing parameters … to assess whether they have adequate capital to survive severe, yet plausible, shocks to some housing markets.”