Wednesday, February 20, 2013

Canadian Real Estate market: Will it crash?

Ok, so the Teranet-National Bank House Price index is out this AM, and as we say in physiques, its deceleration all around.  Yep, fancy that the BoC aggressive stance on new mortgage has finally paid off -- maybe.

Ok so the two really crazy real estate markets in Canada are Vancouver and Toronto (many other places in Canada are in the "crazy" zone but not nearly as bad).  Vancouver has been in free fall!  Well that's what you get when you read the press, in fact over the past 12 months house prices have declined by 2.5% -- that's after a 100% increase over the past decade -- so yes a bit of a correction.  According to the press, Toronto is also in free fall  and in a correction; so far total drop is 0.37% (really not that big a correction).  Now it is true that sales are dramatically lower, hence the bathed-breath headlines because in both markets sales are off by nearly 1/3 which is not inconsequent when you are an real estate agent! It was also the first marker that the US housing boom was coming to an end, sales just dried up!

 I will not discuss the Vancouver issue any further  -- it has been covered elsewhere and has its own peculiarities.  Looking at Toronto the situation is different; until recently Toronto saw an annual population inflow of more than 100,000 individuals -- that has now changed, with a 30-40% drop in the last 12 months (reasons are unclear).  At the same time the number of condo under construction is in excess of 50,000 -- of which 25,000 will be delivered in 2013 -- now that sounds like a lot, but if you think that there are approximately 1,700,000 households in the GTA region (2011 census) then the 25,000 represents less than 1% of the housing stock -- so not really the end of the world, still population is growing by only slightly more than 1%, and a a rule of thumb households grow 1/3 the speed of population, so that there is a problem there.

Stories are that in the core of Toronto, where all these luxury condos are being built the majority are being purchased by speculators -- not people who will acquire the property, but will acquire the right to acquire the property in the hope of selling the condo prior to delivery (and completion payment).  Urban folklore is always amusing, the reality is that so far it has not been a problem!

The math tells you that the number of condo under construction is high and may be slightly ahead of demand, but overall not such a big deal.  The math confirms that although the market is overheating (especially in terms of house price/income) its not fundamentally flawed.  Demand and supply is more or less tracking.  That would mean that the correction is a direct consequence of the BoC's new mortgage rules -- three years ago I used the analogy of a super tanker; it takes a while for a  ship/market to shift in a new direction, but that the rules are finally slowing the Canadian real estate market.

Can the real estate market in Canada crash? -- of course, in the end real estate prices are a confidence game.  How much are you (and your bank) ready to pay for a parcel of land -- to a certain extent that's the problem in Vancouver, many of the more outlandish house purchases were done on an all  cash basis -- no financing.  its a bit like buying a Picasso -- its worth as much as the next guy is ready to pay!  There is no doubt that the Canadian real estate market is "fully priced" as some would say, especially when using the standard metrics of rent/price and gross income/price.  The Canadian economy is a resource based economy (well around 35% of Canada's GDP anyway), China could crash and the demand for oil, steel, electricity, gas, aluminum, copper, zinc and gold could drop, the same for wheat, corn soya etc.   But Canada has had less exposure to insane borrowing/lending practice, there is no real fundamental shift in the owner/occupier as a percentage of the overall population in Canada.  Canadian are fully liable for their debts (unlike many in the US).

My guess is that we will see a 12 to 18 months softening of the Canadian real estate market, and maybe house price increases will better track inflation (which is what happened this year in several Canadian cities) rather than capital growth (which is not the historical norm anyway).

That's my prediction (please note that I rent and do not own a house) I've got no skin in the game!


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