Maybe this time, it really is different. Maybe life expectancies have grown, and with them, people’s willingness to take on more debt. That would mean house prices could stay up higher than history would suggest.
Maybe interest rates aren’t going back up. If there is no inflationary pressure, either in Canada or in the U.S., there isn’t much reason for central banks to push interest rates back up.
Maybe we’re in for an endless housing boom. Maybe. But if history is still any guide to go by, then folks, it looks like we have one whopper of a housing bubble on our hands. Because just about every single indicator that warns economists of trouble in the housing market is now flashing red.
Investment bank Goldman Sachs and British business paper the Financial Times are the latest to throw in with the “Canada has a housing bubble” crowd. Goldman put out a report last month saying that some parts of Canada are suffering from overbuilding, and given the excess construction, a “price decline can be quite significant.”
Meanwhile, FT declared Monday that Canada’s “property sector is perched precariously at its peak.”
Here are nine of the most compelling reasons given by economists for why Canada has a housing bubble. Decide for yourself whether this is much ado about nothing, or a major warning sign for an economy in trouble.
1. House Prices Are Growing At An Unreasonable Pace
House prices in Canada have grown 20 per cent since the end of the 2008-2009 recession — and that’s when you adjust for inflation.
The compare: During this time, the U.S.’s flailing housing market saw a net decrease in prices of about 10 per cent, adjusted for inflation. Maybe a better comparison would be Australia, which, like Canada, is a commodities-heavy economy that does well when resource prices are high. Australia’s house price growth during this time has been half that of Canada’s.
2. We’ve Never Been So Indebted
Canadian household debt has hit a record high of 163 per cent of income, meaning Canadians owe $1.63 for every dollar of income. Tha’s pretty close to where the U.S. and U.K. were when their housing bubbles burst.
And Canadians seem to be going debt-crazy even outside of mortgages. According to a recent RBC survey, non-mortgage consumer debt soared 21 per cent in the past year.
3. Canada’s Gap Between House Prices And Rent Is The 2nd Largest In The World
The Economist magazine reminds readers several times a year that Canada’s housing market is among the “bubbliest.” According to its data, Canada’s housing market is overvalued by 73 per cent, compared to rental rates, when looking at long-term norms. That’s the largest gap among countries where this data is available.
4. Canada’s Gap Between House Prices and Income is the Third Worst In The Developed World
That’s according to the OECD, which released a report this summer saying Canada is “vulnerable to a risk of a price correction.” The OECD estimates that house prices are about 30 per cent higher than they should be, given what Canadians earn.
Canada is part of a small group of countries “where houses appear overvalued but prices are still rising,” the OECD said.
5. Canadian Housing Markets Are Exhibiting ‘Irrational Exuberance’
“Irrational exuberance” is the term Fed chairman Alan Greenspan coined in the mid-90s for a market that is bubbling up. (Four years later, the dot-com bubble burst and Greenspan’s warning proved prescient.)
Canada’s housing markets are also showing signs of irrational exuberance. Despite warnings from even the most optimistic market analysts that house price growth is bound to slow due to tighter mortgage rules, huge house price increases still abound in many markets.
One of the most irrational markets is Toronto, where a large drop in sales in 2012 resulted in … very little change in house prices. When the market picked up again this year (sales were up a stunning 19.5 per cent year-on-year last month), the result was … little change in house prices. This is a sign of a market that has become detached from economic fundamentals.
6. Low Mortgage Rates Are All That Are Holding Up This Market
The housing market optimists, like CIBC economist Benjamin Tal, point out that, for all the increases in house prices, affordability is still actually pretty good (or at least not much worse than normal).
They’re right, but this depends entirely on interest rates staying at current historically low levels. If interest rates go up, so do monthly payments, and affordability is out the window.
How precarious is the situation? Economist Will Dunning, who works in part for the Canadian Association of Accredited Mortgage Professionals, estimates that even a one percentage point hike in mortgage rates would be enough to sink the market.
A one-per-cent increase in Toronto would result in a decline in home sales of 15.3 per cent in Toronto, Dunning estimated recently, while prices would drop by about six per cent.
7. We’ve Never Been So Dependent On Construction Jobs
Canada’s booming housing market in the years after the 2008 economic collapse helped to hold up the economy (much of that thanks to rock-bottom interest rates), but it has also fundamentally changed the economy in ways that could prove to be bad news.
With manufacturing slowly dying as a source of jobs, construction jobs have taken over the slack. Fully 13.5 per cent of Canadian jobs are now linked somehow to construction — the highest level on records going back some four decades. Compare that to the U.S., where only 5.8 per cent of jobs are related to construction.
BMO economist Doug Porter believes this could be a sign of an “unbalanced” economy, and the risk here is that, when the construction market returns to normal (as eventually it must), there will be serious job losses.
8. In Housing, What Goes Up Does Come Down
The conventional wisdom is that house prices are something that just keep going up and up. But historical data shows this actually isn’t true. We have records of home sales in North America going back centuries, and throughout the years, average house prices have always trended back towards a level that’s about 3.5 times median income.
So if the median household income in Toronto is about $70,000, which it is, then an average house should cost $245,000, which it certainly doesn’t. The average price of a home sold in Toronto today is $539,035, a seven-per-cent increase from last year.
It’s hard to imagine Toronto house prices falling all the way back to long-term trends even with a housing bubble collapse, so it may be that, at least on this metric, things really are different this time. Perhaps people’s longer lifespans and greater willingness to take on debt have changed the market permanently. Perhaps.
9. Some of the World’s Most Trusted Economic Sources Are Worried
“Because they said so” is not a good reason to believe anything, but it is telling to see who’s worried about a housing bubble in Canada. Here’s a quick rundown of the people and institutions that are saying a day of reckoning is approaching for Canada’s housing markets.
Goldman Sachs has warned of a “large correction” in Canada’s housing market, due to what it sees as overbuilding of housing units.
Renowned U.S economist Robert Shiller fears Canada is experiencing the U.S.’s housing bubble burst but in “slow motion.”
Nobel prize-winning economist Paul Krugman thinks Canadians have taken on way too much debt, and a “deleveraging shock” is likely in the cards.
The Economist magazine calls Canada’s housing markets among the “bubbliest” in the world, noting that house prices are way above normal levels compared to rent and income.
The Organization for Economic Cooperation and Development (OECD) says Canada has the third-most overvalued housing market in the world, and is part of a group of countries “most vulnerable to the risk of a price correction.”
