The Canadian housing market is teetering at great heights right now. Our neighbor to the north survived the global financial crisis with little impact, but now, there’s some major bubble activity in Canada, especially in Vancouver and Toronto. The Canadian government is taking steps to cool things off, but there are warnings that those bubbles are about to burst.
The Canadian market looks a lot like the U.S. market did before things went south in 2008. Home prices are soaring, personal debt levels are deepening, and at least some of the mortgages are subprime due to loose lending rules. To top off this dangerous mix, almost everyone in Canada has an adjustable rate mortgage, and almost half of them will reset within the next year, putting many borrowers at risk of default.
Soft Landing vs. Crash
Hilliard MacBeth, the author of a book called “When the Bubble Bursts: Surviving the Canadian Real Estate Crash,” said in a Curbed article, “We’re basically in a correction now, which most people believe will be a soft landing.” She’s not one of them, however. She says, “I’m pretty sure it’s not going to be a soft landing. It’s going to be a crash.” (1)
According to Forbes and the Real Estate Board of Greater Vancouver, home prices have risen 337% in 15 years, since 2002. Single-family homes have gone from the U.S. Dollar equivalent of about $314,000 in 2002 to almost $1.4 million today. That’s created some red-hot investment opportunities, but those who believe that prices will keep rising could be in for a rude awakening.
Financial pros say trouble is brewing in Canada. In addition to skyrocketing home prices, interest rates are rising and cap rates on rentals are sinking. In many cases, those cap rates are 1 to 3%. Forbes reports that Canadian price-to-rent ratios are quite a bit higher than they were for U.S. landlords in 2006. And when 47% of mortgages reset in the coming months, many homeowners, already saddled with debt, may find themselves underwater, or worse, unable to meet their monthly obligations. The typical loan in Canada is a 5-year fixed-rate loan that adjusts to the market rate after that. The 30-year-fixed rate loan is rare.
Fear of Subprime Mortgage Repeat
There’s also evidence of a subprime lending problem, although some Canadian real estate experts say it’s a much different scenario than it was in the U.S. Despite that, the “fear factor” can be a danger in and of itself. Canadians witnessed that kind of response over the last few years after Canada’s largest subprime lender, Home Capital Group, announced that it had suspended 45 brokers for approving loans with fraudulent income information. Wikipedia says the estimated value of those loans was as much as $2 billion.
That led to investor panic. The bank’s stock tanked. Many depositors also started pulling money from their accounts, causing a run on withdrawals that almost destroyed the bank. Some people also blamed short sellers who contributed to the problem.
Warren Buffett Saves Canadian Bank
At that point, U.S. billionaire Warren Buffett stepped in to help. He made a $400 million equity investment and provided a $2 billion line of credit in exchange for a 38% stake in the company. The bank’s stock recovered, and recent reports say it no longer needs Buffett’s help but Buffett still owns a share of the company. (2)
While that bank survived, it shows how feelings of uncertainty can trigger an unexpected chain of events. Combine that with a housing market that is bursting at the seams, a private sector debt-to GDP ratio of 218%, and loans that will reset at higher interest rates, and it’s not surprising that financial experts are worried about a Canadian meltdown. Many U.S. hedge funds have also been looking for ways to short the Canadian housing market, according to Forbes.
Policy Changes to Cool the Market
The Canadian government is trying to cool things off. As of this year, uninsured mortgage-holders must undergo a “stress test” to determine if they can handle a rise in their mortgage rate. A government-sponsored enterprise similar to Fannie Mae and Freddie Mac guarantees many of the loans with a high loan-to-value ratio. That enterprise, along with Canadian taxpayers, would be on the hook for loan defaults in the event of a housing meltdown.
Lenders must also abide by new loan-to-value limits. Vancouver and Toronto have also imposed a 15% tax on international buyers to reduce foreign purchases that are driving prices higher.
Uncertainty Near All-Time High
The Canadian market has not collapsed, and there’s no way to know if and when that might happen, but according to a team of U.S. economists, uncertainty about Canada’s economy is spiking. Their Economic Policy Uncertainty Index shows that it’s near all-time highs in Canada. They say there’s a long list of factors contributing to that uncertainty including the current U.S. trade debate, and NAFTA negotiations. (3)
Some Canadian businesses are reportedly postponing investment decisions until they know the outcome. There’s also concern about Canada’s oil industry, and the fate of pipeline construction. Debt is also a problem in Canada for many local governments.
“If you think this time is different…”
If you are thinking of investing in Canada, you may want to wait. The Forbes article had an interesting sign off to this topic. It paraphrased former U.S. President Reagan saying, “if you own a house, sell it. If you are thinking of buying a home in Vancouver, wait. If you think this time is different… Good luck to you!”
That advice could be applied to certain housing markets in the U.S. although our most expensive markets are not yet in that “bubble red zone.”
(1) Curbed Article
(2) Forbes Article
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