Canada's Housing Bubble

Jan 24, 2010 Garth Turner greaterfool.ca

Are Canadians rubes?

When it comes to figuring out what to spend our money on, apparently. Let’s do a little comparison with our American neighbours – you know, those subprimates we’re always dissing as being trailer park while we’re so smart.

US family income, on average, is $67,348. Canadian family income (in US dollars) is $68,305. Almost a dead heat there.

Household debt as a percentage of disposable income is 132% in America and 145% here. Whoops, we lose that one, but not by much. We’re all spending beyond our means.

Retirement savings in the US, as measured by the average 401k plan, is $62,900. In Canada, the average RRSP balance seems to be about $64,000, or $60,800 in US dollars – about the same.

Mortgage rates are, hmmm, similar. In the States a short-term home loan is 3.7%, while here is it 2.65%. But the Americans have the edge in being able to lock in a 30-year mortgage at 5.14%, while we have to renew at market rates every 5 or 7 years.

But what’s a very similar comparison breaks down entirely when it gets to real estate. The average US resale home costs $178,000. In Canada, the national average right now is $337,410, or in US dollars $300,294.

So, a house to the south costs 2.64 times income, and here it is 4.4 times income – which is damn close to twice the price. Not only that, but Americans are able to write off 100% of the interest on their mortgages from taxable income, as well as property taxes. They also enjoy the same capital gains-free status on their homes in essence as we do. The federal government will give new homebuyers $8,000, free, and move-up buyers can get $5,000 as a gift. Oh yeah, then they can sign up for a mortgage rate which will not change for three decades.

And still, with all those incentives – free money, interest-deductibility, rate stability – house prices in that country of 304 million are exactly half what they are here, in a land with one-tenth the people and more land mass. Makes ya wonder, doesn’t it?

I thought of that when I opened my email and found a note from a couple in a city I’d just visited: “We have sold our condo here in Kelowna, and are looking for a house and we are open to moving out of this city, but are not too crazy about living in snow country, we are looking for some insight into what and where is the best place to invest in real estate.  We are 71 and 66 years old, so don’t want to move to an area that is really isolated.  We have a RRIF as well as our government pensions, but wish to protect what we have and spend it wisely.”

Of course in Kelowna, like in Oakville or Sherwood Park or Delta or Red Deer, it’s hard to find a decent SFH for less than $450,000 – which is a third higher than the national average. So why would a couple of seniors (who would never qualify for a mortgage) be considering slamming a big chunk of their retirement cash into a piece of real estate? Are they nuts?

In a word, yes, of course they are. Buying a home with irreplaceable retirement savings when you are 70 or so, at the top of the real estate cycle, is madness. It constitutes real and immediate risk, while it augments daily living costs. It’s also exemplifies one reason there’s such a premium to reside in Canada: We live in a puddle. A vacuum of information. A regional backwater of a country where so many people lay down their savings, unquestioningly.

Real estate costs what it costs because of supply and demand. When demand rises, so do prices. There is every reason to believe Canadian house values are wildly inflated, and by almost any measure. Our market was beginning a worthy correction in late 2008 – sales and prices started to collapse as it became apparent to people houses had passed the ability of average families to afford them.

This correction was halted in its tracks by the actions of the Bank of Canada, acting in concert with the federal government. By dropping the central bank rate to just 0.25%, for the first time in history, the feds engineered emergency mortgages in the 2-3% range, while Ottawa offered insurance for anyone leveraging 95% of a house purchase.

The result was predictable – an explosion in demand. As a result, the average house price in Canada rose last year by 19%, or twenty times the rate of inflation and average wage gains.

This will not last. It cannot last.

Real estate at these levels is enveloping the Canadian middle class in debt. As interest rates begin their inexorable rise in a few months, all of this debt will eventually become far more costly, more difficult to pay and a greater burden on family incomes, which are unlikely to keep pace. It’s almost as if the federal government, desperate to create inflation by any means possible, staving off deflation and political disaster, engineered a real estate bubble.

Could it and the Bank of Canada have known what 2% mortgages would do?

Could they have surmised the creation of a housing mania?

Did they care the impact would be unaffordable shelter for most families? Ballooning household debt levels? Luring young buyers without savings into a financing trap? Convincing 70-somethings real estate is now riskless?

There’s no reason a home in Canada should cost almost twice what it does to the south, in equal neithbourhoods, in a similar society, among families making the same money and with comparable budgets.

How long this can endure is now the question.