Before we get into this post, I just want to thank the readers who contacted me about the comment verification plug-in failing. I've installed a new verification plug-in that seems to work well and is easier to read than the last one. Comments are back!
Canadians love housing! For nearly two decades now, housing has been the economic story in Canada. Thousands of us have become fantastically rich on paper as prices of tiny lots and chipboard went to the moon.
Of course ridiculous amounts of leverage helped. Prices have only about doubled in the past 10 years, but at a 19:1 leverage ratio the gains on equity appear enormous!
The real estate pushers got really rich! With billions of dollars of housing changing hands each year and 4-5% of that for grabs in sales commissions, these folks have made hay.
When times are good, thanks in large part to horrible government policy, the pushers celebrate the rising "natural" condition of the market.
When prices begin to fall, thanks again in part to horrible government policy, these same middlemen furiously point fingers.
An Update on the Market
Well, at the end of summer 2018, prices and sales volumes are falling in nearly every major Canadian housing market. Things are not looking good at all for sellers or people who extended themselves to buy real estate.
Toronto and Vancouver, the two big Canadian market movers, have seen a massive sales collapse in their single family markets. Sales=to=listings ratios have exploded. We are now in what the pushers call a "buyers market". But that doesn't mean it's time to buy!
Prices are slowly falling alongside, but the real reckoning hasn't started yet. The condition of these big markets reminds me of the Prairie markets back in 2015. Eyes have not been opened yet.
For example, the largest Prairie markets, Calgary and Edmonton are continuing their multi-year price slide across the board. The slide began with low volume and isolated good deals, particularly in the condo space. But it has spread and the price concessions are growing rapidly.
Although the house pumper MLS numbers seem to paint a rosier picture, units in my townhouse complex are selling for almost 20% lower than their brand new price seven years ago! Single family houses in Edmonton that sold for $500,000 ten years ago are now selling for $400,000.
Factors Driving Real Estate Prices
As I've stated before on this blog, house prices are primarily the result of interest rates and household income. With a dose of consumer optimism or pessimism to extend the market one way or another.
Household income needs to expand over time to see an increase in house prices beyond the normal rate of inflation (1-3% per year). In the short term, a fall in interest rates can expand borrowing capacity leading to higher prices while a rise in interest rates leads to price compression.
If the Canadian real estate markets were solely dependent on household incomes, the price of a house would be around $290,000 today. That's if Canadian households spent 20% of their income on mortgage costs (the historical long-term average).
Higher income regions like Toronto, Calgary, and Edmonton would see higher house prices. Same goes for areas that appeal to high net worth individuals, certain areas in southern B.C. for example.
However, it does not explain an national average house price of $630,000. These insane valuations are not economically justifiable in our current circumstance.
No region of Canada is even remotely comparable to the world's higher priced regions like Hong Kong, New York, San Francisco, Singapore, or London.
These are the finance, culture, and industry capitals of the world, filled with millionaires and billionaires who can afford expensive homes. And they are not millionaires just because their houses have increased in value, I'm talking real financial assets with the representative income.
Where Things Are Going
Our house price explosion is purely due to a combination very ominous factors. Record household debt and leverage ratios, extremely relaxed borrowing standards for over ten years, reckless government policy support, and a population that is convinced housing is a get-rich scheme rather than a roof over your head.
These big, long-duration parties come with nasty hangovers, and don't be fooled: no party lasts forever.
Over the past few years an untold number of Canadian families have taken on mortgages of $500,000 or more. The monthly payments are approaching $2,700 at today's best discounted rates. As rates creep up over 4% (yes, it seems to be happening), those payments will balloon over $3,000 a month.
Did I forget to mention, that is after-tax money. If you are earning in the 40% tax bracket, you need to earn a gross income of $5,000 just to pay the mortgage.
Those who took on these monster mortgages when the 5-year fixed rate was less than 2.5% will be shocked when they renew at the end of their terms. They will have a choice of paying at least $500 more per month for the same mortgage, or, if they are lucky, refinance and stretch out the term to keep the payments low.
Already a few years ago, deep-diving economists were raising alarm bells about borrowing. There are more than 1.8 million households with monthly mortgage payments exceeding 20% of their net household income. This group has an average savings rate of -13% of their household income.
The evidence suggests at least hundreds of thousands of households across Canada are perpetually dipping into household equity, or accumulating other debt. Canada might not be the U.S.A., but it turns out people are behaving the same here as the Americans in the 2006-2008 period.
I believe many who already stretched themselves farther than they should have will be forced to sell. If I'm correct, we may be looking at an American-style downward spiral right here in Canada... where no Canadian thought it could ever happen.
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