Canadian Real Estate Wealth spoke to financial analyst and author Hilliard Macbeth about Canada’s “inevitable” housing crash, his methodology for determining the market’s 50 per cent overvaluation and how investors will be impacted.
CREW: How did Canada get to this place where a housing crash is inevitable?
Hilliard MacBeth (HM): What happened can be explained like this: the housing market started to enter a bubble in 2000, around the same time as in the U.S. Prices rose from about 67 on the Teranet-National Bank index, for single-family homes, to 167 today, a gain of 2.45 times.
The extreme good luck for Canada is that rising commodity prices, especially oil rising from $10 in 1998 to $140 in 2008, set up an environment of confidence and optimism. As well, Canada has a financing system through the CMHC where banks and other lenders can offer mortgages without taking much risk.
Household debt increased from $1 trillion to $1.8 trillion in 10 years from 2005 to 2015. About three-quarters of this total carries some form of government insurance or government guarantee.
It’s important to understand that the insurance protects only the lender and the homeowner is still at risk for the total loss if the housing bubble bursts. An increase of that amount in such a short time is very rare, but when it has happened in other countries, it’s always been followed by a financial crisis, as the borrowing is used to buy illiquid assets such as real estate.
CREW: How did you arrive at the figures of 40 to 50 per cent?
HM: The best measure of affordability is the ratio of house price to household income. Prior to 2000, this ratio seldom rose about three times, fluctuating between two and three for decades. In the U.S., just prior to their crash, that ratio hit 4.4 times and then dropped down to about 2.5 and now is at three.
Today in Canada, the average ratio is about five times, with Vancouver over 10 times and Toronto about six times. To get back to three times, the average ratio would have to drop about 40 per cent, from five to three, or in the case of Toronto, 50 per cent from six to three. Don’t even mention Vancouver.
The other way to calculate the required drop in house prices is to get the house price index back to the trend line that existed before the bubble. This requires a drop of about 50 per cent on average, although specific geographic markets vary across Canada.
CREW: Are there any specific markets or cities that will be hit the hardest?
HM: It seems very likely that Calgary will be the first market to correct. The affordability multiple was about 4.5 times in Calgary, since incomes there were much higher than Toronto and Vancouver. But now incomes will drop, perhaps substantially, and therefore to get that ratio back to affordability might require a very large correction. Edmonton is similar to Calgary, although slightly less exaggerated.
The surplus of condos in Toronto that is developing is dangerous too, as an oversupply of units could mean that condos, which are difficult to sell except when brand new, will be dumped on to the market by “investors” who have borrowed most of the money. Or by lenders who have foreclosed on the properties.
CREW: What will be the impact on homebuyers and investors?
HM: The most vulnerable groups are Generation Xers, people between 31 and 55. They have substantial real estate assets and large debts with little else in savings. The second most vulnerable group might be some baby boomers, over 55 years old, who didn’t save enough for retirement and were counting on equity in their home to fund their post-working years.
Also, many baby boomers have helped their millennial offspring, younger than 31, to buy homes with gifts of down payments. There will be a lot of pain in some of these families as those younger people get into trouble with their mortgages.
The big winners are those young people who haven’t bought a home yet and will find that homes become affordable again, although they should wait a year or two before jumping in.
CREW: Can you share any advice for homebuyers or investors?
HM: If you are in those most vulnerable groups mentioned it’s okay to sell the property, rent for a while and enjoy being out of debt. You won’t regret it. It might mean having to sell at a loss. Don’t make the mistake of keeping a home you cannot afford just because the price has dropped; it’s better to sell even if it means taking a loss.
And, of course, buy the book and read it. There’s lots of new information that I uncovered in my research and I’m told it’s easy to read.
And if you are lucky enough to have investments outside of real estate be careful to diversify outside of Canada and away from real estate as many listed equities in the financial and real estate sectors will be hit by the crisis in residential real estate.
Hilliard MacBeth is an Edmonton-based portfolio manager with Richardson GMP Ltd. His book, ‘When the Bubble Bursts: Surviving the Canadian real estate crash‘, is published today.