Canada's Housing Bubble

May 19, 2010 Jonathan Tonge americacanada.blogspot.com

This is an observation of the chart shown above released by CREA the other day. The pink annotations on the chart were made by me.

The chart shows monthly home sales and monthly new listings across Canada. Note that these are seasonally adjusted (SA) figures.

New listings-to-sales ratios

Descriptions of letters as depicted on the chart above:

A: Late 1989 - inventory increases while sales remain strong. New listings-to-sales ratio hits 2.1.  Ratio then explodes to 3.8 in early 1990. Housing takes steep downturn that lasts nearly a decade.

B: Between 1998 and 2002 listings decrease while sales strengthen. New listings-to-sales ratio hits 1.1 signifying the beginning of the longest housing boom in Canadian history.

C: By April, 2008 the new listings-to-sales ratio hits 2.1. The housing boom is declared dead. Prices collapse 11% by October (and the ratio hits 2.6 a few months later).

D: Interest rates are cranked lower in the recession (yes housing was saved by the recession, not caused by it). Listings are reduced while sales rebound. By March 2009, the new listings-to-sales ratio hits 1.4. The average Canadian home price increases by over 20% in the next 9 months.

E: April: new listings-to-sales ratio moves above 2.

Buy low, sell high

No matter which way you cut it, it appears that it is better to buy when the ratio falls below 2 and to sell when it moves over 2. Sharp leaps in inventory in all cases proved to be devastating for the housing market. They are strong signals for a market peak as home sales quickly fell thereafter (making the spread even wider).

A ratio below 1.5 is a signal of a market bottom.

What has occurred in 2010 to listings is simply unheard of. The slope of the new listings line is incredibly steep. The only year somewhat comparable was 1989.

Canada's real estate - 1990 versus 2010

1990

• Dollar for dollar homes were less affordable due to higher interest rates and shorter amortizations
• Only 62.6% of Canadians owned their home (ref)
• Unemployment at 7.8% and rising (ref)
• Issues of CMHC NHS mortgage-backed securities totaled $5.3 billion in the four years between 87-90 (ref)
• Inflation at 5% (ref)

2010

• Debt levels today are in real terms 2.5 times as high as they were in 1990 (ref)
• Inflation-adjusted national average home price is 55% higher today than in 1990 and 84% higher than in 1999 (ref1) (ref2)
• Home ownership rates are at record highs (est. 70% 2010 as it was 68.4% 2006) (ref)
• CMHC has extended government-backed insurance to anyone wanting to buy, ensuring that the pool of buyers had been maximized (ref)
• Global financial crisis, unemployment at 8.5% and stabilizing (2009) (ref)
• Debt-to-assets ratio in Canada is the world's worst (during a global credit bubble no less) (ref)
• Household formation to slow as household size begins to stabilize (was 3.5 people per household in the mid 70s and is now around 2.46)
• Domestic population growth slows/contracts (completely reliant on immigration now)
• Deflation is king (ref1) (ref2)
• Huge demographic shift as baby boomers retire; there will be a need to extract cash from real estate equity - I personally doubt there will be enough buyers left to fund the desired level of extraction
• Issues of CMHC NHS mortgage-backed securities in the four years between 2006-2009 totaled over $423 billion. (ref)

Will interest rates rise by much?

Rising interest rates are a catalyst for real estate price corrections.

It will be interesting to see what happens if interest rates rise (or don't rise/fall due to a double dip and deflation). Due to the debt burden, Canadian households have never been more sensitive to an interest rate increase. Assuming that fiat money holds its credibility, don't expect uncontrollable inflation for many years. A tiny jump in interest rates will trigger strong deflationary forces.

That may mean interest rates stay low. It also means you can't depend on inflation to increase the price of your home or shrink the burden of your debt. That's not good news if housing goes south and with it, its equity.