Thanks for joining us for our debate on Canada's housing market. Are we in a bubble? David Madani and Helmut Pastrick answered your questions, below.
Hi: Hope you have enjoyed the debate thus far and look forward to answering your questions.
Our first question comes from Chris in Boston, who is bearish about Canada's housing market:
I live in Boston and went through the correction here, and despite the positive talk by the vested interests that be, I see little real difference between the US and Canada. I'll be moving there soon and plan to rent. As far as I can see, people are tapped out and spending a portion of their income on housing which has always been considered unsupportable, especially if the health of the overall economy is to be considered. You have massive personal debt, little to no savings, insanely low interest rates, negligible down payments, long amortizations, and the CMHC providing massive moral hazard conditions which give the banks every reason to make a loan and few to refuse it. Here the banks offloaded their risk via securitization, there they offload it via government guarantees, and securitization, but a blind eye tends to be turned just the same. How could this be an even remotely healthy atmosphere for Canadian housing?
Great question Boston. And thank you.
There are considerable differences between the US and Canada - the household debt/income situation is Canada is not as bad as the headline number implies. Households in Canada have less disposable income than in the US due to higher taxation for health care. Second, Canada's lenders operate in a more regulated environment and use more conservative lending practices than in the US -- consider than Canada's market structure is more oligopolistic than in the US; 3. Federal regulations for mortgage insurance are fairly stringent and have been tightened; credit conditions are not easy in Canada - cheap but not easy. Some of these factors explain why Canad did not experience a severe financial crisis or housing bust. Canada's housing market and finance system is in good shape.
This next question is from Jay: Assuming we are in a housing bubble, how would you expect it to play out? I.e. which communities would feel it first? Would it be condos followed by cottage country, followed by suburbs?
Housing busts or recessions are usually broadly based affecting all geographic and product markets though not necessarily equally. Typically, the more robust markets leading up to the bust will undergo the larger correction. Obviously I do not see it as a bubble nor do I expect a crash because it is a bubble or prices are too high; it will crash because demand drops during a n economic recession or shock event,.
Given the overbuilding in the condo markets and high inventory, this seems like the market most at risk to a price correction. Major cities mainly.
Next up is a two-part question from Raymond, who moved to Canada last year and has a background in property development.
I have two questions for the Great Debate:
1) about the CMHC and the rules that banks have to obey to in provinding mortgages. why is CMCH accepting that banks use the current income/spending of the applicant and the current interest rate in order to determine the height of the mortgage? Isn't that too risky? Why not consider the value of the property related to the household income and spending? Or an average interest rate instead of current interest rate? And on top of that, why is the CMHC allowing banks to use in their calculations that mortgage plus other debt costs could be as high as 40% of gross income? That is way too much spending on housing/debt I think.
2) how solid is CMHC? In the way mortgages are provided now, many households are having a very tight budget to get everything done. A household with a mortgage of $360,000 will have to pay $300 interest more each month if the mortgage interest rate goes up by 1%.
With assumption that interest fixed period is 5 years, 20% of the mortgage interest terms have to be renewed every year. Lets day that 10% cant stretch it anymore? what happens if 2% of mortgages will encounter foreclosure? Is CMHC solid enough to cover that year by year?
CMHC requires (and has for several years) that borrowers qualify at the five-year posted mortgage rate even if the borrower takes a lower variable rate mortgage. The 40% TDS ratio is standard and is used with a 30% GDS ratio. CMHC is financially sound; It hands over to the federal government more than $1 billion per year. It capital reserve against defaults is adequate for normal conditions.
David, do you have anything to add?
I think the idea of government being heavily involved in the high risk mortgage insurance business in risky period.
Helmut, care to weigh in?
In short, no, I do not think it was a good idea, in hindsight.
Actually, the 40 year am and zero downpayment materialized in 2006/07 when the market was rising and first-time buyers were increasingly squeezed out of the market. Recall, that CMHC's mission is to facilitate homeownership to achieve social and economic objectives. This public policy objective is much debated. Mortgage insurance criteria have been tightened since.
That's a great question. I live in Toronto and have been wondering about this myself.
I think many buyers simply believe that house prices will continue to rise, hence they take on more debt to finance it. Banks are willing to lend. This continues until enough people don't believe anymore.
Great question. GTA prices will keep rising because of economic and market fundamentals and incomes will not keep pace. This the long term outlook. Consider that housing prices have outpaced incomes and inflation (CPI) since records have been kept. Land is the scarce commodity. Households will adapt to higher prices as they always have and over time there will be relatively more renters in the GTA. Please see my report for a fuller discussion.
Helmut, you're based in B.C. Do you have an opinion on this?
The Victoria market is rather soft and prices have been range-bound for quite some time. The provincial government's downsizing plans do not help the outlook. I do not expect prices to drop 10 or 15%; rather more of the same so if you are looking to buy a home it is a good time since you will have bargaining power.
David, I think this next question is for you.
Good question. Honestly it is hard to say. We think around three years, maybe more. We see most of the correction taking place in the largest cities. Ottawa is perhaps somewhat at risk. Not sure about London or Kingston though, would need specific data on those markets.
Depends on when the next economic recession or demand shock event occurs. I do not have an economic recession in my forecast but with Europe on the edge, the risk of recession is 20% in the next year.
Generally, the data shows that supply has been keeping pace with demand. In fact, we have excesses, not shortages.
Prices will fall when demand drops (a recession) and will fall by a lesser amount due to over-supply. Markets adjust, suppliers adjust. starts and listings will decline and stabilize prices.
Rents will increase, but I think prices will rise faster than rents.
I'm not allowed to give specific financial advice...sorry
I am not an expert on Calgary's market but keep a close eye on the economy, migration numbers and of course the housing market indicators released every month. From my vantage point, I think Calgary's market has more legs and beside if you are a long-term investor, a temporary drop in prices is not a problem.
Unless you end up underwater on your mortgage five years from now come mortgage renewal time...
A recession when it hits will be national, international; The average price income ratio is misleading and does not apply to every household. consider than the TDS ratio is 40% so that the maximum loan or price-income is 2.5.
That's what certain economists thought in the US too....
The average income used in the price-income ratio is not applicable to homebuyers. The average used includes all household, owners, renters, young and old. A better income measure would be tone relevant to homebuyers.
David, I know you need to sign off now, and I think you're still responding to the last question, but is there anything you'd like to say in closing?
Sure, it would be nice to have more income data that could more clearly show that house prices are too high....
While we wait for David's closing comments, Helmut, here's a question directed to you...
Yes, the US housing market was falling into a housing recession prior to the financial crisis and resulting economic recession. Housing recessions can occur without an economic recession and if so the housing recession is usually mild.
Helmut, while we're waiting for David's closing remarks, is there anything you'd like to say in closing?
There is no housing shortage problem in Canada. If anything, we have the opposite. The decade-long housing boom has been driven by grand house price expectations and easy credit. This is not sustainable. We expect house prices to correct over a few years.
Housing prices will continue to rise long-term due to supply-demand factors. A drop in price will occur when the business cycle turns down but that will not be a permanent condition. Homeownership affordability will worsen. Bubbles are caused by excessive speculation fueled by easy credit and those conditions currently doe not exist in any meaningful way. such conditions could materialize in the future, but policymakers will act to tighten credit and avoid a US style housing bust. Homeowneship is the bestfinancial investment a household can make; plus you get to live in it and be your own landlord.
David and Helmut, I'd like to thank you for taking part in the Great Debate. I know our readers are always interested in discussing the housing market, and your arguments have made for a lively conversation all week on our website.
Voting will remain open overnight, so check back tomorrow to see who won.