Canada's Housing Bubble

Feb 10, 2010 Max Fawcett maxfawcett

Canadians may be on the verge of witnessing a central banker acknowledge both the possibility of a speculative bubble and his institution’s role in creating it, an event so rare that it makes events like solar eclipses and New Democratic governments look downright commonplace. Despite a global economic recession and a market meltdown to the south, the Canadian real estate market enjoyed one of its best years on record in 2009, with the national average price climbing 5 per cent in 2009 to a record $320,333 and year-over-year figures for December showing a more striking 19 per cent increase. Although Mark Carney, the Governor of the Bank of Canada, isn’t prepared to take full responsibility for the role that his decision to drop interest rates to their lowest levels in fifty years played in real estate’s winning year, he has signaled that Canadians may have overindulged themselves on the buffet of low-interest credit that was laid out for them in the hopes of stimulating consumer spending and staving off the worst effects of the recession.

Carney’s sudden call for fiscal prudence has the ring of a drug dealer telling his clients not to get too stoned, which might explain why those clients aren’t listening. For all the secular sermons that Carney and Finance Minister Jim Flaherty have delivered recently to Canadian homeowners about the importance of fiscal prudence and the impact of impending increases in interest rates on mortgage payments, they continue to double down on real estate and assume what were only a generation ago regarded as suicide-inducing levels of personal debt in the pursuit of the virtues of home ownership.

But if the Bank of Canada’s low-interest lending policy may be the crack-cocaine that is fueling the real-estate market’s recent highs, the gateway drug that facilitated its consumption is the reverential attitude that Canadians have towards home ownership and the corresponding disdain for renting. In an article in the Calgary Herald appropriately titled “Desire to own homes overcame tough times,” Michael Polzler, the executive vice-president of Re/Max operations in Ontario and Atlantic Canada noted that “while low interest rates were a principal factor driving home-buying activity, no one can discount the value that Canadians place in owning a home.”

Polzler’s quote underscores the fact that the mania associated with home ownership has distorted the choice between renting and owning from a rational economic decision to a moral one, potentially blinding thousands of Canadians to both the virtues of renting their homes and the risks attached to owning it. That attitude has been actively fostered by the government programs that incentivize and subsidize home ownership and amplified by the noisy crowd of real-estate agents, mortgage brokers, and HGTV executives who exaggerate its pleasures.

This narrative, one that associates values like stability, cohesion, and prosperity with ownership and shiftless transiency and economic illiteracy with renting, has taken root in the minds of most Canadians. With governments creating various incentives and programs that encourage ownership, the banks providing the easy credit, and the industry spokespeople relentlessly spinning the facts and figures—ones that they usually create themselves—they have managed to transform a rational choice into a universal aspiration, and in so doing make home ownership look like a leap that only a self-destructive idiot wouldn’t take. In our ownership-addled culture, those who rent by choice are regarded in the same way as a self-identified communist might have been 25 years ago: an eccentric figure whose views would be subject to ridicule if they weren’t so obviously ridiculous.

Unlike communism, though, there is a credible case for renting as a rational form of economic behaviour. The notion that renting amounts to a waste of money only slightly less egregious than simply lighting it on fire is a widely held one in North American society, and it’s actively fuelled by bankers, real-estate agents, and other professionals with a vested interest in promoting home ownership. Only a fool, aspiring home owners and the real-estate agents and mortgage brokers enabling them say, would choose to pay down their landlord’s mortgage when they could be paying down their own.

But like most pieces of conventional wisdom, this particular chestnut is a monumental oversimplification of what should be a complicated decision. When the costs of renting and owning are roughly equivalent, renting might well be a wasteful economic decision, but it’s been a long time since that was the case in Canada’s major markets. In places like Vancouver, Calgary, and Toronto, where the price of the average home is anywhere from five to a remarkable ten times the median income of the average home buyer (the definition of “extremely unaffordable” is 5.1 and above, according to market research firm Demographia) renting compares very favourably to owning.

Ironically, in these kinds of overheated markets, many new homeowners remain de-facto renters, as the combination of low down payments and rising prices create degrees of financial leverage that negate the vaunted forced savings effect of home ownership that real-estate agents and mortgage brokers love talking up as a benefit of buying. Instead of wasting their money by paying their landlord’s mortgage as renters, they’re now wasting it on interest-heavy mortgage payments, and subsidizing the big bonuses of their executives in the process.

When the hidden costs of ownership are factored in, from property taxes and common fees to mortgage insurance, real-estate agent commissions, and provincial taxes, home ownership starts to look downright reckless. As David Crook wrote in a 2007 piece for the Wall Street Journal, home ownership isn’t nearly the bargain that most of us think it is. “Boom market or bust,” he observed, “home buying has so many extra costs — from upfront “points” paid to a lender to title insurance and appraisal fees — that over the first five to seven years, a renter who invests the equivalent of a down payment in stocks could easily do better overall than a house buyer. Compounding that problem: Most homeowners move within seven years.”

What about price appreciation, you wonder? Over the last fifteen years, home prices in Canada and the United States have marched determinedly upward in one of the longest real-estate bull markets in history, one whose pitch has been so steep at times that it spawned an entire industry of parasitical speculators who made easy money buying up properties and flipping them months later for a healthy profit. The proliferation of these flippers, and the ease with which they appeared to make their money, became so striking that it encouraged many people to think of real-estate as an asset that “always goes up.”

A longer view of the situation reveals a less predictable pricing environment, though. Robert Shiller, the Yale economist who correctly predicted both the dot-com and American housing bubbles, has a century’s worth of data that demonstrates that over the length of the average mortgage the price of a home in the United States barely outpaces the rate of inflation. Canada’s real-estate has beaten the rate of inflation like a red-headed stepson for over a decade now, which, along with the unprecedented levels of un-affordability and a guaranteed increase – more likely, a series of them – in interest rates over the next few years suggest that a correction of some sort may be in store. That’s certainly how David Rosenberg, the chief economist at the money manager Gluskin Sheff in Toronto, sees the market. He examined home prices in relation to personal incomes and residential rents and concluded that prices are between 15% and 35% above levels that are consistent with fundamentals.

Yet even in the face of what looked like the beginning of a real-estate correction last spring, Canadians remained resolute in the preference they expressed for owning rather than renting their homes. In June of 2009, a national survey commissioned by Genworth Financial Canada and conducted by the Environics Research Group revealed that of the 2,521 people surveyed, 88 per cent say they would feel more financially secure owning their own home. This survey offers an under-appreciated window of insight into the mind of the average Canadian homeowner, and demonstrates just how little rational economic self-interest really has to do with the widespread pursuit of home ownership. After all, a clear-headed and honest assessment of the relative merits and drawbacks of owning and renting should be an effective buffer against the kind of cult-like mania that has gripped the real estate markets over the last decade, but still the mania persists, as anybody with a grade twelve education who’s paid even the slightest degree of attention to the real estate pages in Vancouver, Calgary, or Toronto ought to understand.

This mania’s endurance has a lot less to do with the forces of supply and demand than its industry advocates might like to argue. Instead, it is the result of decades of cultural brainwashing on the part of the real-estate industry and its various accomplices in the worlds of government and finance that have made an unemotional evaluation of the financial merits of home ownership next to impossible for the average home buyer. Together, they have convinced millions of North Americans that owning real-estate is more an existential transaction rather than a financial one.

Governments have encouraged this confusion by using the owned home as a proxy for a wide variety of causes, from anti-communist nationalism in the 1950s to middle-class family values in the 1990s. As Elizabeth Eaves wrote in Forbes Magazine in a July 2007 article, “homeownership has been touted as civic responsibility, “moral muscle” and a bulwark against communism. A 1922 pamphlet from the National Association of Real Estate Boards even promised that it would put the “MAN back in MANHOOD.” Over the years, it has been claimed that homeowners vote more, join more voluntary associations, take better care of their residences and have better-educated kids.” As Thomas Sugrue observes in a piece for the Wall Street Journal in 2009, “to own a home is to be American. To rent is to be something less.”

These governments didn’t just talk about the importance of home ownership, either. On both sides of the border and both sides of the political spectrum, elected officials have used their legislative and financial clout to create substantial incentives to home ownership. In the United States, Freddy Mac and Fanny Mae were created, while in Canada the Canadian Mortgage and Housing Corporation was created by the Government of Canada after World War II to fulfill a similar purpose. Those measures reached an absurd zenith in the United States in the late 1990s and first years of the new century, as the invention of creative financing measures allowed people who had no business owning homes – most infamously, those without either incomes or jobs, who received the so-called NINJA loans from particularly adventurous banks – to participate in the orgy of home ownership. When the lights finally came on in 2007, millions of Americans were caught with their pants around their ankles.

Yet even this cautionary tale, one that has forced millions of Americans into foreclosures and millions more with negative equity in their homes, hasn’t dampened the enthusiasm that Canadians feel about the semi-spiritual virtues of home ownership. When asked by those same Environics researchers if “owning a home provides a greater sense of emotional well-being and security,” eighty-four per cent said that it does. Even those who understand the financial and personal sacrifices associated with home ownership, from higher monthly payments and the risks associated with a depreciating market to more mundane inconveniences like cleaning the eaves troughs and replacing the hot water heater, still believe that they made the right decision. When asked if they’d rather own than rent “even though home ownership may mean more work and effort,” 85 per cent of respondents agreed.

In America, where almost one in four home owners are now underwater, the prejudices towards renting and those who engage in it that so many people held have softened considerably. But in Canada, where the real-estate bubble has managed to survive a deep global recession, renting is still looked down upon, an economic choice that sits somewhere between collecting bottles and trading junk bonds in our collective cultural hierarchy. Whether we’re doomed to follow in the footsteps of our cousins to the south remains to be seen, but it seems clear that until we do our love affair with the owned home will continue unabated, evidence to the contrary be damned.