Why Canada isn't immune to a U.S.-style housing crash - Macleans.ca

Why Canada isn’t immune to a U.S.-style housing crash

A new report warns that Canadian home prices could fall 30 per cent in the next five years

Skeletons of abandoned housing developments

Skeletons of abandoned housing developments in California in 2009

Investors should stay away from the Canadian housing market, warns a new report from Chicago-based investment firm Morningstar. A house price correction is “inevitable” within the next five years and could send house prices falling as much as 30 per cent.

The report’s author, equity analyst Dan Werner, also takes aim at some of the more popular arguments on this side of the border for why Canada’s housing market is fundamentally different from the U.S. housing bubble. “Many investors believe that financial crises are things that happen to other people in other countries at other times; crises do not happen to us, here and now,” he writes. “History has shown, time and again, that ‘this time’ is not different. We believe the same is true for the future of Canadian residential real estate.”

Skeptical? Here are some of the myths Werner debunks for why Canada isn’t immune to a U.S.-style housing crash:

Myth: Canadian buyers are more cautious than Americans because U.S. laws prevent banks from seizing homebuyers’ assets, such their savings and cars, if they default on their mortgages (otherwise known as non-recourse lending.) Outside of Alberta, Canada doesn’t have such laws, meaning homeowners can’t simply walk away from their mortgages.

This has been a popular theory for what helped cause the housing crash south of the border. But it’s wrong. Roughly 80 per cent of U.S. states actually do have laws that allow banks to confiscate the assets of defaulting borrowers. They include Florida and Arizona, two states particularly hard hit by the housing bust. But, Werner writes, such laws don’t mean much, since people who default on their mortgages don’t typically have many assets for banks to seize, other than their house. “Short of reinstituting vagrant prisons, the implementation of recourse does not have a meaningful impact upon bank losses when a housing bubble bursts.”

Myth: Americans took on riskier mortgages because they could deduct their mortgage interest from their income taxes while Canadians don’t have that option.

Typically, only 20 per cent of American homeowners actually take the mortgage-interest deduction. Those that do tend to be wealthier, since they’re the ones who pay the most income taxes. Among households earning less than $50,000 a year fewer than 10 per cent deduct their mortgage interest and they save an average of just $120 in taxes.

Myth: Canadians put down bigger down payments and have more equity in their homes than Americans did before the housing crash.

The average Canadian homeowner has a mortgage worth 45 per cent of the value of their home, meaning they have 55 per cent equity. It seems like a lot, but 55 per cent home equity is exactly where the U.S. average was in 2005. At the same time, 23 per cent of Canadian mortgages have a loan-to-value ratio above 80 per cent, which means those borrowers have less than 20 per cent equity in their homes. The U.S. looked nearly identical at the height of the bubble: 22 per cent of mortgages had loan-to-value ratios above 80 per cent.

RSPs have become a major source of cash for down payments for first-time homebuyers. More than 2.5 million Canadians have cashed in their RSPs to buy a house. But in recent years nearly a quarter of them have had trouble paying back the money, Werner writes. They’ve either missed the deadline to repay or aren’t paying the required annual minimums. That’s money that gets taxed as income, hitting cash-strapped homeowners with an extra financial penalty. It’s also evidence, Werner writes, that sizable shares of homebuyers are struggling to pay down their debt.

RELATED: Who said it? Take the Canada-U.S. housing bubble quiz

Myth: Immigration is driving Canadian residential construction.

There are an average of 1.8 people immigrating to Canada for every house built. But the typical Canadian household has 2.5 people. This year Werner says we’re on track to build around 20,000 more houses than we’ll need — and, he writes, we’ve been overbuilding now for more than a decade.

Myth: The Canadian government has been steadily tightening the rules for mortgages: requiring higher down payments, shorter amortization periods, heftier insurance premiums and more proof of income. This will ensure a “soft landing” for the housing market.

Canada is among a number of countries, including Israel and Norway, that have dramatically tightened requirements for new mortgages since 2008. None of that has done anything to cool the housing markets in those countries. Why? As long as mortgage interest rates keep going down, governments are powerless to put the brakes on house-price growth. “For banks, it is easier to find a way around firmer regulation than it is to evade higher interest rates.”

Myth: Canada Mortgage and Housing Corporation has more than enough money to withstand a modest house-price correction.

The report calculates that even a “modest” 20 per cent drop in house prices could trigger as much as $12 billion in CMHC’s default insurance claims – or 75 per cent of the agency’s $16-billion capitals reserves —if the correction causes widespread defaults.

Myth: Interest rates have been going down for years and will keep going down for some time.

Over the past 30 years Canadian homeowners have indeed had a pretty good shot at seeing their interest rate go down every time they renewed a five-year mortgage. Some might be tempted to think that a declining interest rate is the norm. But in fact, Werner argues, over the long-term it’s extraordinarily rare: “Getting a lower mortgage rate five times in a row is essentially the same as flipping a coin and getting heads five times in a row—a statistical probability of two per cent,” he writes. Chances you’ll flip a coin for a sixth time and come up with a lower mortgage rate? About one per cent.

In fact, Werner predicts that over the next five years mortgage rates will return to their historic averages of around five per cent, up from the three per cent that’s typical today. In that case, he calculates that housing costs could easily consume 75 per cent of the average Canadian household’s take-home pay.

Think this time it’s different? Think again. Or take our quiz to see if you can guess which quote about the housing market came from an official in the U.S. in 2006 or Canada in 2014.


Why Canada isn’t immune to a U.S.-style housing crash

  1. Wow – a lot of those “myths” strike me as straw man arguments. For example:

    “Myth: Canadian banks are better protected because, unlike the U.S., Canada doesn’t have no recourse mortgages (outside of Alberta). That means our banks can seize homeowners’ other assets if they default on their mortgage.” I suspect Canadian banks were better protected because they have more conservative lending practices and don’t provide sub-prime mortgages.

    “Myth: Americans took on riskier mortgages because they could deduct their mortgage interest from their income taxes while Canadians don’t have that option.” I think the consensus is more that Americans borrowed more for their mortgages because the income tax deduction acted to inflate prices by subsidizing what the borrower was paying for the mortgage.

    “Myth: Immigration is driving Canadian residential construction.” Canadian residential construction is being driven by demand and rising prices. You don’t need overwhelming numbers of immigrants to have that effect – just enough to impact the marginal price of housing.

    “Myth: The Canadian government has been steadily tightening the rules for mortgages – requiring higher down payments, shorter amortization periods, heftier insurance premiums and more proof of income. This will ensure a “soft landing” for the housing market.” Well, that’s the hope. It’s more than the US did. Time will tell if it works, and if it does, it’ll be to the chagrin of analysts trying to short the Canadian real estate market.

    “Myth: Canada Mortgage and Housing Corporation has more than enough money to withstand a modest house price correction. The report calculates that even a “modest” 20 per cent drop in house prices could trigger as much as $12 billion in CMHC’s default insurance claims – or 75 per cent of the agency’s $16-billion capitals reserves —if the correction causes widespread defaults.” That’s a big if. Also, 20% is a pretty big correction. 2008 was a historically huge bubble in the US at 30%. More typical have been corrections of ~10%.

    “Myth: Interest rates have been going down for years and will keep going down for some time.” I honestly don’t know anybody naive enough to believe that.

  2. The majority of Canadians buy into all these myths, including most of my family members and relatives. I am pretty much the only one don’t believe in it. At the current price, it has to crash. The biggest housing crash in Canadian history is not far away. The price in major city has to go down by about 50% in order to be affordable for working Canadians. I refuse to buy anything at the current price. I do not want to be debt slave that I have to work all my life to pay back the bank. Hell no…..

    • I hate to break it to you, but affordability for working Canadians isn’t necessarily the key determinant for housing prices. The real issue is the size of the housing supply relative to demand of people with money to buy it. If you had 10 houses for sale at $1 million each, and there were 20 people who could afford a $1 million price tag, you’ve got sufficient demand to hold or increase prices. It wouldn’t matter if there were another 1000 people looking to buy a house, but couldn’t afford to pay more than $200,000. There are plenty of reasons that housing prices could or should decrease, but an argument that it needs to be affordable for a “working Canadian” isn’t much more than a personal value judgement.

      • George, do you know that there are millions of home owners that are deep in debt? Our debt level is higher than the US was at their peak. It’s more than 70% of new Canadian home buyers required insurance from the government for their mortgage. In the other word, they don’t have the 20% of down payment for the property. There are good portion of them has only 5% down payment. It’s sad that we didn’t learn anything from the US. In addition, our cost of living is much higher than in the US. Yeah, we have universal healthcare which is nice but our taxes are also much higher. For Americans, the difference is more than enough to purchase insurance.

      • If REAL inflation is 9%, and your mortgage payments are 3%, there is a 6% value gain in owning a home with debt.

        That being said, the practice by BoC/Ottawa thin air money is highly inflationary, can people get low mortgage rates while money depreciates to a point where a litre of gasoline is $12?

        Be it inflation on food, interest rates, or cost of living over all, Canada has and is going to be downgraded more. Our current economic outlokk is simple, unsustainable. A negative value depreciating economy of debt has no good future possible. Just depends if you get squeezed on interest rates or inflation on everything else and more likely both at the same time.

        In the end, its hyperinflation as money loses value to thin air money creation for debt ruins the value of money. EVERY nation in history that does this gets a negative outcome. But it keeps the musical chairs running for another round before the inevitable happens.

  3. At nearly 70 percent or more ownership rates and house prices risen over 200 percent in many locations in the past decade, 20 percent correction is hardly going to be problem for the rich Canadians.

    • The problem is it will be way more than 20% and there are millions of home owners have less than 20% of equity in their houses. I suspect our crash will be proportionally larger than the one in the US few years ago. They also have more debt than just their mortgage. Good luck to them.

    • Not really. Homes, gas, oil, food, appliances, insurances, utilities didn’t go up, the value of money decreased.

      Ottawa creates “thin air” (electronic counterfeit) to buy government debts as savvy lenders do NOT lend money for return rates below inflation to lose value. Since 2006 the new model is thin air money for government debt, and its highly inflationary and devalues money.

      How it affects Canada isn’t going to be like Greece, its going to be more like Argentina with rapid hyperinflation from currency devaluation. Part of why I am reducing investments in Canada as in terms of Yuan and USD, Canada is a depreciating tax inflated economy of debt. Devaluation of Canada in the last 8 months has been 7%, expect that to increase.

      Also expect worker participation to fall, as with lower value money, with so much real and hidden taxes, protectionism and high costs, jobs will leave as people can’t afford as much goods and services. Affordable exchange of goods and services drives jobs and its not as affordable for a lot of people in Canada…will be less jobs.

      But I am sure Ottawa will tax us more to solve a problem it creates.

  4. Ignore this article. Home prices will go up, but should fall behind real inflation any time soon.

    The author ignores a key point, Ottawa’s willingness to create inflation and devalue CAD money. In terms of USD, our homes HAVE NOT appreciated on average in the last year. A 8% up tick in homes is offset by a nearly identical loss of CAD money value and inflation. In terms of USD or Yuan, the two largest world currencies, Canadian’s home prices haven’t increased nor decreased in value. Ok, maybe slightly. But hey, homes are homes and do not depreciate as fast a Ottawa thin air fiat money.

    Hey, if I devalue money by 50% and a home costs 100% more, then the value has not changed. Canada’s currency is not as stable as Yuan or USD.

    The real issue and risks are cash flow related, can people keep their homes if their wages are devalued and food, clothing and essentials cost a lot more? As be it higher interest rates or higher inflation, the debt bills will be paid. There is no free in govmint “thin air” money to buy their debts that no legitimate lenders buy.

    We are entering hyper-inflation, all the signs are there. Devalue money to preserve bloated govmint spending.

  5. How many articles does this make about the impending doom in Canada’s housing market? It seems that about once or twice a month, some journalist writes this same story.

    Yes, some locations are booming and it doesn’t take a genius to know that booms often lead to busts. But that is not all of Canada’s housing market.

    There are no where near the conditions that created the US housing bust (sub prime anyone?)

    Get a new story please.

  6. This article makes some very good points. For me, the most convincing argument is that nothing goes up endlessly. People tend to assume that what is happening now can be extrapolated indefinitely into the future and then go out and borrow increasing amounts of money to buy what is hot at the time. Eventually, prices get to a point where the pool of buyers becomes insufficient to support prices and then the excessive amounts of debt force some sellers to accept lower prices. This is a repeating pattern throughout history for many different asset classes.

  7. Chicago investment firm is clueless about Canada.

    I agree in terms of USD and Yuan, our home prices will come down. But not in terms of CAD money.

    Ottawa will devalue CAD money to 60 cents, drive up inflation crazy and more tax greed, and then lie to Candians about REAL inflation.

    Already happening. If I told someone in 1960s that CAD money would lose 10% of its value in 6 months they would be shocked. But it has happened int he last year, as we are down to 93% money.

    Yet dumb politicians wonder why we don’t invest as much any more in Canada. Because after exchange returns, taxes and poor company earnings, Canada is now a lousy place to invest except for a very small number of companies.

    Its why this Canadian investor now invests outside of Canada. One thing the Harper/Trust lie taught me and reinforced, in Canada govmint is your worst enemy of wealth. Which reminds me, I have more money to invest outside of Canada and look for a good exchange rate. Far too much economic ignorance and insanity in Canada, we are going to see a huge hit on currency….

  8. Here is what will happen, and is already started. I will compare par CAD and USD and then look forward 5 or 10 years.

    You buy a $500,000 home at par USD as a year ago, $400,000 mortgage in USD/CAD money.

    This year the CAD money mortgage is now depreciated, its only $372,000 USD!!!! Yep, use NEGATIVE VALUE FIAT MONEY to your advantage.

    As in 5 years, we will have 65 cent money, in 10 years we will have 50 cent money. At 50 cent money the mortgage is just $200,000 USD.

    At 50 cent money it also costs twice as much to build a home. With wage/tax increases, a home will for sure sell for much more. Tax inflated are we, the $500,000 home today will be worth $1,000,000 or more in 10 years. And those inflation gains are tax free!

    Only possible way we could see a value drop is if immigration is halted and population shrinks. Its the only real possible way we could see a value drop in housing is via population drop and massive unemployment in major centers.

    We even thought of moving up, as devalued money is a decline in value and stocks, dividends are taxed even if the gain is purely inflationary and not a real value increase. But gains on a home you live in, tax free on the gains.

    Two differences to the USA, our homes are our best investment in Canada because of insane levels of taxation, and our immigration is loose as a goose to keep population growing and tax revenues up despite domestic baby population being below 1.5 per family.

    2005/6 of “thin air fiat debt fraud money” changes the entire economy on debt and currency. It caused the mortage crisis in 2007 as legitimate lenders like me ceased lending for return values below inflation. Ignored, this caused the 2008 meltdown.

    I realize in greater depth what really happened, and not the BS govmint lines on it was mortgages. It was really that legitimate lenders stopped buying governemtn debt, so they had to create it out of thin air in the illusion of solvency.

    We have a setup for 70s like hyper-inflation as US and Canada are devalued.

    BTW, I have lived in USA and Canada, Canadian born.

  9. In terms of USD and Yuan, he is right. In terms of CAD he is wrong.

    CAD money should be a 60 cent value inside of 50 years. Canada is bankrupt, and devlauign and its already started.

    If a home cost $400,000 CAD/USD to build a year ago, it now costs $430,108 CAD to build the same home. Home price inflation on appliances, materials, wood and labour have gone up in terms of CAD. StatsCan openly lies about this but the cost are real.

    Hey, I am not going to sell tons of concrete for a basement for 93 cent money when I can get a whole USD even if its made in Canada….

    Buying a home you live in NOW makes sense, as money is a rapidly depreciating asset and that will devalue the loan. Use negative value money to your advantages, especially if you are young with a good cash flow/income. Our governments can’t raise rates much as they are technically bankrupt and can’t afford the debt they have. Devalued money is assured!!!

    And in your own home, devalued money doesn’t translate into inflation taxes. In the last 10 years, our home is twice the value, 100% inflation as its still valued at one home. Yet I owe no inflations gains taxes, this, it outperforms a stock investment with 100% gains as I would have to pay inflation gains taxes.

    Its why a home is a Canadian’s best investment going. And if you reduce the mortgage to zero, start saving/investing you will eventually be a 1, 2 or 3%er.

    Stop listen to idiot economics….do the math with pragmatism. We empty nesters are seriously considering moving UP from our $600k home as to remove inflation taxes…huge long term financial benefit.

    Do the math, include inflation, include devalued money, include taxation….your own home is you best investment in Canada. And its a negative value currency, debt depreciates the day you take it.

  10. A hint about the best way to manage mortgage rates. ITs statistically assured that on average, always going for the lowest rates possible is your best bet…however there is an exception.

    You need to know the cash flow you can afford for mortgage, what is the interest rate effect on your cash flow? Can you afford 5%? 7%? 10%?

    Reality is Canada is a bankrupt nation, I can’t really see rates going above 5% even if we have 25% inflation, as money now has a negative value. Add in that Ottawa, provinces, cities carry well over $2 trillion in debt, low rate greed is certain to continue and that means a devalued Canada currency is assured. I say $2 trillion as I include $600B+ Ottawa, $600B CHMC, many $100s of billions from provinces, CPP and crown corp shortfalls in debt and pensions, and thats before I get to cities … 5% interest on $2 trillion is $100 billion a year! $90 billion more than today!!! Our broken governments at all levels can’t afford it.

    Future financing of debt, investments needs to account that we are entering a hyper-inflationary depreciation phase and unlike the 70s, Ottawa can’t afford to back the CAD money value. We could see CAD at par with the peso or Yuan in 10-15 years.