Canada's Housing Bubble

November 25th, 2009 yattermatters.com

You Did Ask!

Derek Holt and Karen Cordes economists with the Scotiabank Group have compiled an enlightening report entitled ‘Is There a Canadian Housing Bubble?‘ Meaty in its reading, Holt and Cordes’ evaluation of the Canadian Real Estate Market stands beyond the scope of this post.

With due respect to Holt,Cordes and Scotia Group, this author provides a synopsis while offering the entire report for your consideration.

Chart 7 24-11-2009 11-22-54 PM

Chart 6 24-11-2009 11-22-19 PM

Chart 5 24-11-2009 11-21-19 PM

Chart 4 24-11-2009 11-20-32 PM

Chart 3 24-11-2009 11-19-39 PM

Chart 2 24-11-2009 3-18-57 PM

Chart 1 24-11-2009 3-18-10 PM

Highlights:

How Rich is the Market?

“Canadian house prices are rich no matter how one looks at it, but they are likely to become richer yet before material risks emerge later next year and beyond.”

A: Doesn’t Matter Which Scale – It’s Heavy

Affordability.

• Only compares present home ownership
• does not address fair value of the asset

History Perspective – Chart 1

• Current vs past house prices
• average price more than double in this decade

US versus Canada – Chart 2

• equalizes the picture
• no matter the view, house prices are high –
• up 86% this decade

Adjusting the Field – Chart 3

• compares house prices to broader economy prices –
• 70% rise this decade

Price to Rent – Chart 4

• shows own vs rent at all time high but they say:
• “Note that one should only pay attention to the trends in this chart. We’re comparing prices to the rental component of CPI, so the level of the measure means nothing.”

Price to Income – Chart 5

• at all time high but, they say:
• “it is somewhat analogous to a carrying cost calculation but not one that is skewed by emergency low levels of interest rates as standard affordability calculations.”

Nobody Missed the Party – Chart 6

• Toronto and Vancouver 1/5 of Canadian market but, they say:
• Regardless, all Provinces have experienced a strong pace of price gains since house prices started to rise at the beginning of the decade

B: Volume

Sales//Supply – Chart 7

• “high resale prices is a combination of a sharp, concentrated sales recovery alongside tight supply conditions”

Renovations- Chart 8

• “It was high before Federal incentives kicked in, but they have probably helped insulate against other down-sides in keeping the volume of spending elevated”

Inventory – Chart 9

• “new monthly listings depressed, the total stock of listed properties in relation to current selling rates is also very low”

5 Things but only “Once in a Century”

1. No Expiration

• “Canadian housing stimulus programs are not structured like they are in other countries in that they relatively lack expiration dates.”

2. Liberalized Mortgages

• “brings into the market people at an earlier stage than would otherwise be the case, and purchasing more expensive than average properties”

3. Rising Interest Rates

• “Low interest rates are driving healthy affordability right now,but this effect will wane in the next 2-4 years”

4. No Supply

• “likely to respond and ratchet higher on both listings and new home construction next year”

5. Over and Out

• “long past the point at which strength can be attributed to unleashed pent-up demand from last Fall”
• “surprise is that prices didn’t stay down”

Canadian Mortgage Market Changing

What we Have

• “off cycle compared to other countries”
• “stronger banks”
• “prudent regulations”
• “good management”
• “strong structure”

Since 2006

• material innovation
• significant impact
• thin mortgage data

Amortization

• “it was 25 or bust until three years ago when 30, 35, and 40 year amortizations became available. Now, after just three years, 18% of outstandings are over 25 yrs. 10% are 35-40 years.”

Equity Withdrawal

• “18% of Canadians withdrew equity from their homes over the past year. The average amount was $41k, and the total was $46 billion. 52% of those withdrawing equity used some for debt consolidation, 40% used some for renos, 13% used some for purchases/education, 16% for investments, and 9% for other reasons like consumption”

Terms

• “often unrecognized, fixed in Canada is not like fixed in the US”
• “US borrowers have relatively juicy rates for the long haul”

Other Things

• survey low balls the subprime share of the market
• forms of innovation are nothing close to the mistake of mass-marketing what were at best niche products like Ninja mortgages

US vs Canadian Mortgage – the Differences

• “night and day apart”
• “Canada’s subprime market is small – isn’t anywhere near as exposed”
• “isn’t even really subprime per se. Canada’s subprime market is more like the U.S. near-prime market”
• “Canada never had the zero-rate teasers that existed in the U.S.”
• “Canada’s mortgage equity withdrawal market is much smaller”
• deductible – “vastly different incentives to leverage oneself in the two markets”
• “innovation was needed in Canada, but has been relatively more conservative”
• investor mortgages – magnitude of the exposure in Canada is far less significant
• funding model is completely different
• majority of the securitized totals have been done through the CMHC
• Canadian financial institutions are not as reliant upon short-term lines
• Canada MBS investors do not face the same heavily leveraged investor risks
• Canadian banks continue to apply prudent underwriting standards
• Appraisal standards are generally higher in Canada
• Canada provides recourse to lenders unlike the U.S.

How Much is Yours?

• Canadian household debt relative to incomes is high by the country’s own historical norms
• no doubt that the consumer bankruptcy picture is deteriorating in Canada and so are mortgage delinquencies
• remain far lower than that experienced in other major markets

BoC Implications

The Question – “would accelerating home prices materially affect inflation risks, given that the BoC is among the stricter inflation-targeting central banks?” Their Answer – “not likely.” Why?

• Canadian price index – “total owned accommodation accounts for about 16%.”
• According to the ‘Shelter table’ – “Replacement cost on its own accounts for a small 3-4% of the total CPI basket, and aligns most closely with new home prices.”
• “resale prices do not directly show up in the consumer price index.”
• “it is not at all inconceivable that the pace of house price gains will come to slow in any event for reasons” [noted above]
• Dollar value “more important influences on imported components of the CPI basket than housing.”
• “BoC candid in acknowledging a strong domestic economy, against which is weighed the fully offsetting influences of a strong Canadian dollar”
• “BoC’s latest projections have housing flat-lined on a contribution to GDP growth basis in 2010 and 2011 such that their clearly communicated concern thus far has been that housing strength won’t last.”
• “BoC has little reason to be concerned as yet – little concern over credit growth in Canada”

*Disclaimer: All information, quotes, graphs Courtesy Scotiabank Group. All trademarks are the property of Scotiabank
** Full Scotia Group Report