Join Date: Sep 2009
Could a U.S.-style collapse happen here?
EmailPrint..Tom Fennell, On Monday December 20, 2010, 5:25 pm EST
Home ownership is at the centre of many Canadians' financial retirement plans. That's especially true for baby boomers who are sitting snugly atop a nice wave of real estate inflation.
In fact, the average price of a detached home in Canada has doubled since 2000, and in September was sitting at $331,000. Of course that number pales when compared to Vancouver, where the average price for the same period was $679,000 and in Toronto it was a still-high but a more modest $427,000.
So a lot of people nearing retirement age are hoping the housing market will stay buoyant until they cash out, allowing them to downsize, pay off their debts and still have plenty of money left over.
A lot of American homeowners used to think that way. But from their peak in 2005, U.S. house prices have fallen almost 30 per cent, and they are still trending lower. Things are still so bad in the U.S. that the real estate default rate hit a record high in 2010, with more than three million households receiving foreclosure notices. And it could get even worse in 2011.
But could a U.S.-style collapse really happen here?
Obviously Bank of Canada Governor Mark Carney thinks so, and last week urged politicians and Canada's banking oligarchs to tighten mortgage lending requirements to slow Canada's plunge into debt.
To say the least, our debt numbers do look unsettling. According to Statistics Canada, the Canadian household debt-to-income ratio hit a record high of 148.1 per cent in the third quarter. That is slightly above the 147.2 per cent debt ratio seen in the U.S., according to latest figures from the U.S. Federal Reserve.
Carney also noted that household debt has jumped by seven per cent since the recession bottomed out, compared to a fall of 3.5 per cent in the U.S. And most of the household debt in Canada can be attributed to mortgages, which have grown from $421 billion in 2000 to more than $1 trillion today, a 137 per cent increase in 10 years.
This mountain of debt has left Canadians exposed to a housing-price correction. "Risk reversals, when they happen, can be fierce," warned Carney. "The greater the complacency, the more brutal the reckoning."
By three important measures, according to the International Monetary Fund (IMF), Canadian housing prices are extremely overpriced when compared to U.S. housing prices at their peak in 2005. And by implication, whether it will be "fierce" or not, they are due to correct.
For starters, according to the IMF, Canadian home prices relative to income are 15 per cent above the post-1970 average. This may not sound all that bad until you compare it to the U.S. and the fact that before prices there began to tumble, relative to income they were 11 per cent above the long-term average.
Long-term averages are something that smart investors pay attention to because prices often return to their mean. Just ask anyone who owned tech stocks in 2000 or gold bullion in 1980. In the case of housing, a regression to the mean would imply a return to long-established price trends based on historical levels of appreciation, and according to the IMF Canadian house prices are now selling 60 per cent above their historical average.
That sounds like a scary number, and it probably is when you consider that just before the U.S. housing bubble burst, prices there were tracking 30 per cent above their historical average and have almost fallen back to that level.
After looking at all those numbers the IMF concluded that on a price-to-rent basis, Canada has some of the most expensive real estate in the world.
In October the buy/rent ratio was about 1.85x. This means with average mortgage sizes increasing and becoming more difficult to afford, homeowners pay almost twice what renters pay to put a roof over their heads.
It should be pointed out that at 1.85x it's getting very close to the 2.3x level reached in December 2007 and the 2.5x level reached in 1988, and those highs led to corrections of 13 per cent and 10 per cent, respectively
Those findings are supported by a Royal Bank of Canada study which found that nationally, a typical house eats up 41 per cent of median income today, compared to 49 per cent in Toronto, and 73 per cent in Vancouver.
Just to put those numbers into perspective, according to Statistics Canada, median after-tax income has been growing at around 1.8 per cent annually this decade, well behind the doubling in real estate prices over the same period.
Here's a final bit of analysis that should raise a few eyebrows. The Canada Mortgage and Housing Corporation has insured $773 billion in mortgages and loans, while holding only 1.2 per cent in equity.
But at its worst before it went technically bankrupt, Fannie Mae, the largest mortgage insurer in the U.S, had 1.5 per cent equity in its loan portfolio.
So does this mean the Canadian real estate market is a bubble that is about to burst?
Only history will answer that question, but if you believe long-term trends matter when it comes to investing, odds are that housing prices will return to the mean. If you use past housing corrections as a guide, a correction could shave 30 per cent off their current values.
In the process, it also will also force a lot of baby boomers back to the drawing board to reschedule their retirements.