The word on the (Bay) street, and in the news media, is that of an overdue 'correction' in Canada's housing markets. Some are more alarming than others and liken Canada's housing market to that in Ireland. Others sound more calming and speak of a 'soft landing.'
Households and investors worry that if the concerns of an inflated housing market were true, would it lead to a drastic collapse. Is the roof about to cave in?
A look at the long-term trends suggests that Canada may experience a 'correction'. However, a housing market collapse similar to the one experienced by Ireland or the United States is unlikely to occur. Furthermore, Canada's housing markets are largely swayed by a small number of relatively large markets in the Greater Vancouver, Calgary, and Toronto. If there were to be a correction, it is most likely to be confined to those urban markets that have experienced above average gains in the past few years.
In a recent comment in the Globe and Mail, Tara Perkins compares Canada's housing market to that of Ireland. A line in a 2007 report about Ireland's housing market gave her the chills. It read: "Most available evidence would now appear to suggest that the housing market appears to be on the way to achieving a soft landing." The real estate collapse in Ireland concerns Tara because she hears similar muted warnings of a soft landing for Canada.
The warnings may be similar, but that is where the similarities end. A look at the long-term trends in house price appreciation between the two housing markets reveals how different they are as one compares the Consumer Price Index (CPI) for housing for Canada and Ireland (see the chart below). One simply can't miss the spike in shelter costs in Ireland that started to rise in early 2006 and lasted until the fall of 2008, returning a record 61 per cent increase in over a 34-month period. In comparison, the Canadian CPI for housing does not depict any sudden spikes, and instead suggests a gradual appreciation of shelter costs.
Source: Federal Reserve Bank of St. Louis
In the eight months following October 2008, the CPI for shelter in Ireland dropped from 143.4 to 93.3 (35 per cent decline) causing havoc in the housing and other markets. Even a long-term review of Canadian housing markets do not reveal either a sudden exuberance-driven spike or an hung over crash in property markets like the one seen in Ireland.
The concern about Canadian housing markets is largely driven by the higher rates of house price appreciation in Canada's large urban markets, such as Toronto, Vancouver, and Calgary. In the early eighties, the average housing prices in local housing markets were similar in magnitude to that of the overall Canadian average (see the chart below). Afterwards, however, local markets started to experience greater price appreciation over the Canadian average. Toronto and Vancouver took off in the mid-eighties, while Calgary broke away from the national average in 2005. Whereas Toronto experienced a sluggish housing price appreciation in the nineties, Vancouver continued to appreciate at faster rates, picking up even more steam starting 2002.
Source: Canadian Real Estate Association
Another important factor to consider, which was also highlighted by Ms. Perkins in the Globe, is the record low mortgage rates that facilitate borrowing larger amounts for real estate acquisitions. The chart below confirms this fact. Since the early eighties, we see a gradual decline in mortgage rates along with a sustained increase in shelter costs.
A sudden increase in mortgage rates is feared to prevent a large number of households from servicing their mortgages. At the same time, we see an unprecedented increase in the household debt to GDP ratio for Canada, suggesting that Canadian households may have over borrowed and would feel the pinch if debt servicing becomes expensive. These are serious and legitimate concerns.
Source: CANSIM
The other concern is about how much of the household debt comprises the mortgage debt. If the housing prices collapse, which some economists have warned, what will it do to loan to value ratios and default rates in Canada?
Given that we expect the population in Canada's large urban centres to continue to increase by millions, mostly sustained by immigration, we are, to some extent, immune from the drying up of local housing demand. This suggests that as long as urban Canada is the preferred destination of immigrants from South- and South-East Asia, workers and capital will continue to flow to fuel Canadian housing markets. This is, however, more relevant to the markets in the short-run.
In the long run, we will all be dead, and that is all we know for certain. In the meanwhile, it never hurts to keep your debt (housing or otherwise) in check.
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