Will The Canadian Real Estate Market Crash?
Is Canada on The Brink of a Housing Crisis? In the last decade, house prices in Canada have skyrocketed in value, meaning home ownership is nowhere near attainable by a large majority of the residents of Canada, especially in Vancouver and Toronto.
Due to the large increases in value, one would conclude that the housing market in Canada is in a bubble and that it is only a matter of time before it bursts.
But is this true?
In this article we discuss a few points which could be contributing to a housing bubble and market crash in Canada.
- Price trends
- Affordability concerns
- Price comparison
- Causes of price increases
- Cyclical markets
- Market bubble trends
- Comparison to US bubble
- Contributing factors
- Benefits of crash
- What are my options?
- Government intervention
- Publish this article
- Price Trends
Before we investigate the various reasons as to why there is the possibility of a housing market crash in Canada, we’ll highlight how monumental price increases have been.
Real Estate Price Trends in Canada
On average, house prices in Canada have experienced an annual growth, negating the financial crash of 2008.
As can be seen in the figure below, the average property in Canada will set you back around $500,000, however this is the national average – Toronto and Vancouver have astronomical house prices; A small 1-2 bed condo costs around $800,000 on average in Vancouver, rising to the multiple $millions. In Toronto, even the less-desired properties are averaging over $1m.
Vancouver and Toronto are the least affordable areas to live in the whole of North America – the price to earnings ratio in these cities are the highest in North America.
Rising prices are causing difficulty for young generations to purchase real estate in the major cities and surrounding areas as wages and inflation have not kept up with real estate prices.
However, it is not only the younger generations who are struggling with the current market; recent increases in Canadian mortgage rates have in turn increased monthly repayments for many residents, which is further squeezing the already struggling working families.
Further to this, real estate investors are also finding the current market difficult – new, tougher mortgage stress tests for BTL investments are proving extremely difficult to overcome causing many investors to hold off on purchasing new units.
Price Comparison to The 1970s
As an example to showcase the difficulty many are having in starting out on the property ladder, or simply keeping up with mortgage repayments, take a look at the comparison of current times to the 1970s below:
1970s: The median Canadian income was around $8,000. The average Canadian house price in the 1970s was around $32,000. In other words, wages were around 25% of the average property value.
2019: The median Canadian income is around $59,000 and the average house price is around $475,000. From the figure below, you can see that there is a significant difference; current average wages are around 12% of property values.
What Has Caused Such a Large Price Increase?
There are a number of reasons which have contributed to extreme price increases in Canada.
Primarily these factors consist of artificially low mortgage interest rates, leading to more transactions, thus reducing the number of available units, this in turn pushes prices up.
Low interest rates have been accompanied by heavy foreign investment along with extremely high overvaluations.
Check out our article on investment fundamentals to further understand price drivers within the real estate market.
It seems inevitable that there will be some sort of price correction – real estate markets are cyclical: Price corrections are inevitable, especially after periods of extreme growth.
However, it should be noted, that in general, even after a crash or correction, the market will continue to rise, due to various factors such as an increasing population and thus demand for residences.
Market Bubble Trends
To greater understand whether there will be a crash/price correction, we can analyze previous markets prior to collapse/correction.
In the figure below, we can see the typical cycle of the property market.
Prices will steadily increase, until a point where there is a rapid price correction: The market won’t necessarily fall into a recession as shown in the figure – the market will usually experience a price correction which will fall to a mean, which we have marked as the red line.
Comparison to The US Housing Market Price Correction
If we compare the current situation in Canada to that of the US housing bubble, it becomes evident that there is a high possibility of a price correction in the near future.
Various factors which contributed to the US real estate market collapse are also present in current times in the Canadian real estate market, primarily the unsustainable, rapid growth in prices.
This can be seen in the figure below: The current price to rent ratio is currently at a peak in Canada, similar to the trend which was exhibited prior to the US housing market crash.
Factors Which Could Contribute to a Price Correction in Canadian Real Estate
As noted above, there are various factors which were present prior to the US housing market correction, which are also visible in today’s market.
The contributing factors which are displayed in the current real estate market of Canada which could cause a real estate market price correction are as follows:
- Stagnant wages
- Overvalued property
- Rise in interest rates
- Decrease in investor transactions
- Decrease in foreign investment
- Increasing bank debts
- Subprime mortgage-backed securities
- Possible “dirty” money inflating prices
Stagnant Wages Wages in Canada have not kept up with inflation rates and have definitely not kept up with the skyrocketing prices of real estate. Adjusting with inflation, the average wage in Canada has increased by 1c since the 1970s.
Overvalued Property Property has been overvalued, pushing prices up and up. Even the old, rundown properties are being sold at premium prices in today’s market; an old 5 bed residence built in the 1960s could set you back at least $1,000,000, only to require further funds to refurbish the entire structure.
Rise in Interest Rates Toward the 4th quarter of 2018, interest rates in Canada were increased to 1.75%. Although this may seem fairly low compared to other countries, it is the highest rate since the financial crash of 2008.
This means that the already squeezed working class will have to find an extra sum of money each month to keep up with mortgage repayments.
Decrease in Investor Transactions Since the interest rate increases, the real estate market in Canada has seen a decrease in transactions from institutional and personal real estate investment. This was also the case during the initial 12 months after the UK Brexit vote.
This may be due to new, tougher mortgage stress tests making it harder to turn a profit. However, in any case, a decrease in transactions can stagnate the market.
Decrease in Foreign Investment In the past, Canada has seen $billions of foreign investment injected into the real estate market, especially from China. However, in recent times, investment from foreign countries has been slowing.
However, along with resident institutional and financial investor transactions decreasing, this could only be due to knowledgeable investors playing the waiting game until a more attractive purchasing opportunity arises.
Increasing Bank Debts Banks and investment firms generate their income from acquiring debts from individuals, however, in order to grow and generate more income, they must continually acquire new debts.
After the financial crash of 2008, lending criteria were extremely strict, however this seems to have been relaxed in recent times; subprime mortgages are again available among other “bad debt” options, such as a Car or Vehicle title loan.
With this car or vehicle title loan, you are basically borrowing money against your own vehicle, which unless it is a rare, appreciating asset, will cost you in the long run – borrowing money against a depreciating asset is strongly advised against.
Subprime Mortgage-Backed Securities One of the key causes of the financial crash of 2008 was subprime mortgage backed securities. Many mortgages and other loans are still issued in present times.
If a substantial number of people default on repayments to these loans, it could cause a snowball effect of unpaid debts, leading to another market crash, which is predicted to hit the US in 2020/2021.
Possible "Dirty" Money Inflating Prices Reports have suggested that the real estate market in Canada has been used as a laundromat for $billions in dirty foreign money, which could have pushed prices up in British Columbia between 3.7% and 7.5%.
Benefits of a Market Crash in Canada
A poll has suggested that around 2/3rds of Canada want a housing market crash; as home ownership is near impossible for a vast majority of the population.
The main advantage of a real estate market price correction would be that home ownership is much more attainable for those who are currently struggling to find a mortgage deposit.
A price correction would, as the name suggests, bring prices to their “correct” value – Prices generally tend toward the overall average value. As can be seen in the figure below, there may soon be a price correction to the average value (dotted line).
Source: RBC ECONOMICS
What Are My Options?
While a housing crisis sounds like an extremely negative phrase, it doesn’t have to be. There are opportunities which are found in market bounces. However, you may be thinking whether you should buy, sell or hold.
We wouldn’t completely advise against purchasing in the current market: If you find a cheap listing that is too good to pass on, then by all means take it.
Further to this, if you are set on purchasing a multi-million $ residence, then ensure that you will be able to keep up with repayments if they were to peak under a market collapse.
However, since current prices are overly-inflated, as a price correction is inevitable, it would be advisable to hold off until prices are reduced to an acceptable value.
If you have owned your home for numerous years, you may be apprehensive to sell up. While selling shouldn’t be your first option, it could be a means to generate a substantial amount of profit in a peaking market, after all, it is currently a seller’s market.
If you aren’t keen on buying or selling up, similar to above, ensure your property is not too highly-geared and that you are able to keep up with mortgage repayments – A price correction could also leave you in negative equity.
There have been numerous taxes and laws applied to the real estate market in Canada in order to slow the growth, with a few of these consisting of:
- Non-resident speculation tax
- Rent is only allowed to rise at rates posted in annual provincial rental increase guideline
- Develop standard leases that would further help protect tenants and ensure landlords
- Create program to balance the value of surplus land assets
- Put a vacant properties tax into place
- Tax to make sure new apartment complexes is similar to other current complex properties
- Introduce a 5-year program to facilitate the building of more rental apartments
Read more here.
While there may not be a complete market crash similar to that in 2008, it does seem likely that the Canadian real estate market is in an over-valued bubble and will inevitably burst, leading to a price correction of up to 40%. However it should be noted, a 40% decrease is a worst case scenario.
Various sources believe that increased mortgage stress tests and increased rates have been set in order to cause a market collapse.
While these measures may slightly contribute to a correction in prices, their main objective is to protect home-owners and banks – if you are unable to pass a mortgage stress test, you’d be unable to make repayments during a market collapse, so the country as a whole is safer and better off.
Further to above, lenders are much more apprehensive to lend against risky properties and bad credit ratings in today’s real estate markets.
For this reason, at EMC2 Property, we do not believe there will be a complete real estate market crash in Canada, but rather a small price correction – as is common in many other real estate markets across the globe.
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