Analysts Debate Housing Crash Potential

Housing prices are unsustainably high in Canada’s major centres, says a report from the Canadian Centre for Policy Alternatives (CCPA).

“The steep rise in house prices in so many cities displays all the hallmarks of an accident waiting to happen,” says the author and researcher, David Macdonald.

Canadian-US-Home-Prices  (Chart courtesy of C.D. Howe Institute. Click to enlarge.)

Macdonald makes some fair points about the overvaluation of real estate in certain markets (here’s his full report).

He feels the catalyst for any large price declines will be mortgage rates. Canadian real estate bubbles “have historically been burst by relatively small increases in interest in mortgage rates,” he told Business in Vancouver.

“All you need is a 1% increase in the mortgage rate above the two-year average in a given month and that’s what popped every single bubble in Canada, two in Vancouver and one in Toronto.” (For the record, inflation, excess supply, and speculative buying also played a big hand in past bubble burstings.)

The solution, Macdonald says, is to:

A)  “Slowly” go back to 25-year amortizations on insured mortgages;

B)  Ensure the Bank of Canada increases rates by no more than approximately 1% over a rolling 24-month period; and,

C)  Encourage banks to forego mortgage profit and refrain from passing along rate increases when the Bank of Canada hikes its overnight rate.

From a practical standpoint, these “solutions” make little sense.

For one, long-term amortizations are already significantly priced into home prices. Tens of thousands of buyers have used 30- to 40-year amortizations. Therefore, home prices have already been bid up with the aid of longer amortizations. Eliminating long-term amortizations at this point may be too late. It could potentially pull the rug out from demand and accelerate the natural price declines that analysts say are coming.

Secondly, the Bank of Canada has one overriding target: inflation control. All else comes secondary. If inflation is approaching the danger zone, the BoC will raise rates—regardless of the critics, home prices, currency rates, etc.

Thirdly, most borrowers with long-term amortizations are well-qualified and able to withstand price declines and payment increases.  Removing financing flexibility from strong borrowers penalizes responsible Canadians and offers little benefit in return. Remember, 35-year amortizations carry only modestly more default risk than 25-year amzs—statistically speaking.

Mortgage-Rates-3As for banks taking a hit by not raising rates in the face of soaring funding costs, this could be the most ludicrous proposal we’ve seen in months, for four reasons:

  1. Banks have a mandate not to lose money;
  2. Bank shareholders would revolt against the resulting compression in interest margins;
  3. Postponing rate increases only delays the inevitable. When mortgage funding costs skyrocket (i.e. when market rates for BAs, bond yields, etc. jump higher) banks must raise their rates at some point.
  4. Big 6 rate fixing would be predatory to non-bank lenders (who don’t have the balance sheets to withstand extended margin compression). Mortgage rate controls would therefore violate free-market pricing and jeopardize smaller lenders.

Macdonald’s unrealistic “solutions” may be the reason critics call his report a left-wing ploy for headlines. Whatever the case, there are no shortage of counter-opinions to refute impending doom in Canadian housing. One is this report from the C.D. Howe Institute, coincidentally released on the same day.

Report author, Jim MacGee, says: “A comparison of housing market policies in Canada versus the US…suggests that there is little likelihood of a US-style surge in foreclosures or a collapse of house prices in Canada.”

Canadian lenders have “avoided the sharp decline in underwriting standards seen in the U.S…and continue to mitigate the risk of a massive wave of defaults in the future.”

MacGee defines the Canadian government’s exposure to “higher-risk loans” as “small.”

All things considered, few would argue that real estate is not richly valued in our major cities. Accordingly, most believe a natural price correction is coming—anywhere from 5% to 15% (more in some areas and less in others). This correction should likely be sufficient to deflate home prices without any further government or bank intervention.

____________________________________________________

CCPA:  Founded in 1980, the Canadian Centre for Policy Alternatives (CCPA) calls itself “an independent, non-partisan research institute concerned with issues of social, economic environmental justice.” The CCPA is a registered non-profit charity and depends largely on the support of its 12,000+ members. More…

C.D. Howe:  The C.D. Howe Institute is a “national, nonpartisan, nonprofit organization.” C.D. Howe began in 1958 to research and promote educational activities on issues related to public economic and social policy. It is currently chaired by former Bank of Canada governor, David Dodge. More…

  1. You could have a field day picking apart all CCPA reports. They are not a serious organization, and should not be weighted to counter against any serious study. Good analysis showing why, but frankly at this point their reports shouldn’t see the light of day. Don’t give them the press.

  2. The CCPA is actually a very reputable organization and they have done very good work.
    The CD Howe Institute is a joke. They are in Harper’s right hand, and have helped destroy the economy.

  3. LOL!
    Bob = CCPA
    Joe = CD Howe
    I think the CCPA has a point about a possible correction when you look at the data and consider mortgage rate increases coming. However, I agree with Rob that the solutions are completely out the window. I’ve never heard such crack pot solutions in my life.

  4. I seem to recall Jack Mintz and the CD Howe Institute coming out against the GST cuts. And they`re definitely against changes to the census.
    So there seem to be some inconsistencies with your smear… perhaps you were thinking of the Fraser Institute.
    IMO, it`s fair to say that the CD Howe Institute has a much better reputation than the CCPA, especially among economists. And agreed that the proposed solutions are prima facie ludicrous, especially the suggestion to encourage banks to forego profits on mortgages.

  5. “we’re back to the way underwriting was 20 years ago when you had to have a down payment, you had to have a job.”
    Good post Jason. Anyone who thinks canada is in the same boat as the US should read this article. Imagine, you now need good credit and a job to get a mortgage now adays!

  6. Serious question: Why is “banks taking a hit by not raising rates” such a “ludicrous proposal” ?
    Didn’t they not pass on the BOC rate drop on the way down at least one time?

  7. I totally agree with CCPA. Do the math. One might think that because of the 35 to 40 year amortisations that housing has been priced 10 to 15 years into the future locking in these prices and gains of interest for the lenders. I am convinced that this is not in the best interests of the home owners and they are/have been effectively used. Most are not traders nor speculators but need a secure place for themselves and their children. It seems to me everything today is being turned into a speculative sport for the sophisticated manipulators. So now that the average joe has been “locked up” for the next 40 years and taxed at about 50% of his/her income, what’s the next game going to be. “Too many people to really give a damn about anymore!” and just like our Gov’t, the Banks are not concerned about collatoral damage and are ‘really’ ‘only’ concerned for themselves. Oddly enough, the Gov’t and the Banks, depend on ‘us’ for their existence.

  8. “Accordingly, most believe a natural price correction is coming—anywhere from 5% to 15% (more in some areas and less in others). This correction should likely be sufficient to deflate home prices without any further government or bank intervention.”
    Do you think really that once prices fall 15% that they will stop there? I’m looking to buy my first home and I’m in no huge rush. Once prices fall 15% do you think I want to plow my $100,000 down payment in to a home only to see it potentially disappear in a matter of months and my payments set to only rise as interest rates increase? Screw that, I’ll wait for the sellers to drop their prices even more. Let the carnage begin.

  9. David
    If you really had $100,000 you would be wise to plow it into Real Estate. Prices falling by 15% is highly unlikely. Think back to January 2009 when the worst financial crisis in many years hit, prices were down by as much as 13%, rates were low and buyers saw the window of opportunity and started to buy. The market became so busy that it shattered sales records and drove prices up to levels higher than they had been pre crisis. We are seeing the same pressures at work and I think we may be in for a busier market than these reports would have us believe. Rates are now at their lowest point in 50 years (again) and anyone who knows about rates and Real Estate is going to smell the opportunity.
    People like you will be sitting and waiting for the bottom to fall out for a long time. While you wait, you will lose your chance to own and your savings (from renting and tucking away the difference between rent and mortgage payment) will dwindle in GICs or some other vehicle paying you 2% on your money.

  10. Its funny how the whole media is saying Canada is in a Housing Bubble. Usually bubbles occur when no one is aware of them (or at least very few). This is absolutely not the case right now as everyone and their Mother is saying that housing is in a bubble. As a contrarian, I would say that there is very little chance that we’re in a bubble currently. I mean, house prices are expensive in Vancouver, Toronto etc, but so too are they in New York, London, Paris, Tokyo. Maybe whats happening is that Canada’s profile and standing in the world (due in part to our wealth of natural resources that we’re exporting hand over fist to China and the world) is finally rising to be among the BIG players for once.
    Could the current correction (which has already taken prices down 5% or so according to many reports) take prices down further? Of course it could. But what happens then? Just like 1 year ago, Buyers will RUSH IN. As a previous poster said, the world was ending 18 months or so back and yet prices fell, bottomed, buyers came in and took them back up again. House prices right now are about the same as they were 3 years ago. Is Vancouver expensive? Yes. Is it one of the most preferred cities to live in the entire planet? Yes. As long as Canada has a strong Resource based economy we should do just fine. So, I ask, what bubble?

  11. Laura,
    “Think back to January 2009 when the worst financial crisis in many years hit, prices were down by as much as 13%, rates were low and buyers saw the window of opportunity and started to buy. The market became so busy that it shattered sales records and drove prices up to levels higher than they had been pre crisis.”
    The only reason the market recovered after 2008 was because the BoC lowered rates even further than they were. The reason prices are even higher than they were pre-crisis is mostly due to these lower interest rates and the BoC’s promise not to raise them until mid-2010.
    “We are seeing the same pressures at work”
    What pressures? If you are implying that buyers are pressured to buy again, only the most foolish of buyers will be jumping in now solely because of low interest rates, with interest rates certain to rise in the future and prices still at their extremely unaffordable peaks.
    “Rates are now at their lowest point in 50 years (again) and anyone who knows about rates and Real Estate is going to smell the opportunity.”
    Rates are temporary. The price you pay for your home is not. Ignoring prevailing interest rates for a moment and monthly payments, housing prices are extremely overvalued right now. If you’re looking to buy a home/condo and then flip it, sure it’s nice when rates are low. Of course it’s also great when prices are low as their is more upside. Do you really see more upside in this market for flippers? I’m not looking for opportunity. I’m looking to buy a home while still having money leftover in my pocket and not have negative equity in my home and be unable to move later if I need to.
    “While you wait, you will lose your chance to own…”
    Not if prices fall.
    “…and your savings (from renting and tucking away the difference between rent and mortgage payment) will dwindle in GICs or some other vehicle paying you 2% on your money.”
    Not as much as my savings will dwindle if I buy now. If I buy now my savings will dwindle because I won’t be able to save as much because a mortgage is much more than rent at current prices. Even worse, if prices go down, any equity in my home and any further equity I put in my home will disappear. Finally, if interest go up and my payments increase, my ability to save will decrease even further.

  12. Take your $100K, and short a REIT, if you’re so sure.
    Home prices relative to GDP per capita, is quite a bit more healthy than they were in the US when there market collapsed. So is our fraction of average loan to value.
    Japanese THIRTY year fixed rate mortgages are lower than our posted FIVE year fixed rate mortgages. Mortgage rates can go quite a bit lower.
    Home prices, are just as easy to predict, as equity indices.
    Why are bears always rude, and bulls always so humble? Maybe cause they have been wrong 75% of the time, for the last 100 years.
    Of course, you might be right; ‘carnage’ could be on the way. In 2005, I was warned after my first home purchase we were in a bubble. “I was dumb”, one person said. I sold in 2008, for $50K profit. Again when I re-invested in a second home, “You’re a moron, house prices are going to fall” they said. I sold this year. A $25K gain. I just bought home number 3. I now have $75K in possible downside, before I start to go into the red.
    All the best to you David, I hope you get a good deal, one day. I hope I don’t lose my shirt.
    JNM

  13. Phil what you seem to be suggesting is some type of paradigm shift in relation to housing prices in Vancouver, Toronto, etc. Maybe you should heed the words of the late John Templeton when he said “The four most expensive words in the English language are ‘This time it’s different.’” The real estate cycle will always be that, a cycle. Where do you think we sit right now?

  14. Lots of lay people were saying the US was in a bubble by 2005 but those with a vested interest in cheerleading house prices (developers, banks, real estate agents, government) said the opposite until it became impossible to deny the truth by 2007/2008. That’s the problem with housing: Too many salespeople depend on it for their livelihood which makes it hard for the uninformed public to get unbiased information. Realizing that’s the way it is, it’s probably best if folks take what the “experts” say with a grain of salt and instead focus on price/rent, price/income and related metrics as their primary guide.

  15. Thanks, David. I think you offered the most honest statement on this page: “Rates are temporary. The price you pay for your home is not.” Rates are much less significant in the long-term than price so it’s worth waiting.

  16. DTG, exactly! Thats my point. Prices are dipping just now and likely will a tad more. They’ll finish dipping, flatten out, then rebound and at some point in the future go to new highs again (with the sam naysayers moaning all the way along).
    So, I agree, its not different this time, its exactly what normally happens.
    God luck

  17. So you think after 8 years of a bull cycle in real estate we’re in for a few months of a bear cycle? Seems a little optimistic. Take a look at Vancouver residential prices graph: http://www.yattermatters.com/2009/08/vancouver-residential-average-july-09/
    Look at the time period after the boom in 1981. The 1981 to 1987 in particular. Also take a look at years 1994 to 2002. If things are truly not different this time people should prepare for many years of flat to declining prices after this last boom. After all that would be completely normal.

  18. Seriously. Who is anyone to tell a business it should take a loss and not make a legal profit? How would you like it if someone told you to give up 1/3 of your pay for charity? Would you do it? No.

  19. Toronto detached average sold home price in the 416 area is down OVER $100k!!
    March 2010 detached home sales in the 416: 1353
    March 2010 detached home average sold price: $698,378
    August 2010 detached home sales in the 416: 676
    August 2010 detached home average sold price: $588,687
    That’s a 16% decline in average sold price for detached homes in the 416… why isn’t that a headline in the newspapers??
    These stats are from the Toronto Real Estate Board and they don’t mention any of this in their review of the stats they just keep talking about it being higher than last year, but they don’t mention the fall from the peak this year… shameful…
    ————————————————-
    Almost bought my first home in March and glad I didn’t since I would of lost about $100,000.00 in just six month. Went on MLS to look at the prices and they are now $80-110K lower in just six months. The real estate market looks like it will continue to drop for awhile so going to wait and save $$$$$$$$$$ by not buying. Don’t believe everything a realtor tell you cause i would of lost $100,000.000 if I did.

  20. Toronto detached average sold home price in the 416 area is down OVER $100k!!
    March 2010 detached home sales in the 416: 1353
    March 2010 detached home average sold price: $698,378
    August 2010 detached home sales in the 416: 676
    August 2010 detached home average sold price: $588,687
    That’s a 16% decline in average sold price for detached homes in the 416… why isn’t that a headline in the newspapers??
    These stats are from the Toronto Real Estate Board and they don’t mention any of this in their review of the stats they just keep talking about it being higher than last year, but they don’t mention the fall from the peak this year… shameful…
    ————————————————-
    Almost bought my first home in March and glad I didn’t since I would of lost about $100,000.00 in just six month. Went on MLS to look at the prices and they are now $80-110K lower in just six months. The real estate market looks like it will continue to drop for awhile so going to wait and save $$$$$$$$$$ by not buying. Don’t believe everything a realtor tell you cause i would of lost $100,000.000 if I did.

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