Weekend Reading: Canadian Housing Bubble Edition

Housing Bubble. Source: http://www.irvinehousingblog.com/blog/comments/emergence-of-shadow-inventory-to-push-prices-lower-in-2011-altos-research/The talk about housing prices and bubbles never ceases. I’ve been doing some thinking on this topic, myself; I don’t quite see the Canadian housing market as being in a bubble, myself, due to our recourse loans encouraging people to stick it out rather than default, and the fact that stricter lender requirements should mean that more of the lendees should have the ability to pay. This does not mean that high housing prices will not have a drag on the economy as over-leveraged people end up throwing most of their income into high monthly carrying costs.

One commonly accepted measure of housing affordability is the median price multiple. A good ratio of median price to median income is a ratio of around 3 times. In many Canadian cities, this index is now in the mid 4s and even reaching the 5s, signalling that housing prices are on the high side.

My own personal rule is that no more than 33% of net income should be spent on housing costs. In my own personal case, we will achieve that, but our income (which I personally consider to be normal middle class in terms of living standards) is a bit above the Canadian average, we don’t yet have kids, and we are buying a small condo, not a house. What about your family making 50-60k a year, or how about a single person making 40k or so a year. Will they also be able to afford a home, or will they be priced out of the market and forced to find something on the outskirts of the city or in a more run-down area?

There’s been plenty of discussion on whether the Canadian housing market is in a bubble or not; after all, housing in our neighbours to the south is now significantly cheaper! If you’ve owned property over the past few years, the rise up in prices must surely feel good; on the other hand, if you’re looking to buy, then the prices are quite high, indeed.

Instead of asking whether we’re in a bubble or not, I’d like to turn the question around and ask my fellow readers: Do you see a justification for a continued run up in prices, like we’ve seen in the past 5-6 years? What do you think that would mean for the average family, on the average family income?

My second question is what do you think will happen if interest rates rise 2 or 3 percentage points? As interest rates came down, families were able to buy a more expensive home for the same monthly carrying costs. How do you think that will affect the supply and demand?

Unfortunately, we have no crystal ball that tells us how things will be like in 5 to 10 years. We can, however, ask ourselves some basic questions, and see where the answers lead us. What do you think?

Weekend Reading

My friend Mich at Beating The Index had his first guest post over at Money Smarts Blog: 6 Reasons Canadians Should Invest In Oil Stocks. Go and check it out, and then let him know what you think!

I did a mini-roundup yesterday, so be sure to check those guys out, too.

Have a great weekend, everyone!

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  1. says

    Thanks for the mention Kevin!

    I do not believe a run up in prices is justified in the coming years especially as interest rates rise. I am not a believer in a Canadian housing bubble burst but i expect the prices to stabilize for an extended period of time and maybe even slightly correct.


    • says

      Agreed, Mich. Without a runup in interest rates, I think the current situation is stable, and we will see neither big rises nor large falls across much of the country, though Vancouver may still be vulnerable. All bets are off should rates significantly rise.

  2. says

    I didn’t think Canada had a housing bubble like the US and all in all they were much more sensible about who they loaned mortgage dollars to….. is this not correct?

    • says

      Hey Grouch,

      Canadians are still in a huge amount of debt, and the high prices effectively price many new entrants out of the market. Those without big mortgages will be fine, but anyone who bought in the last 3-4 years has a big mortgage. Although most borrowers are at least somewhat credit worthy, and recourse loans will scare them from walking away, the fact is that we are still a highly leveraged society. Things are fine, now, but if you add a lot of weight things might not be so fine. Check out the graph here: http://www.thefinancialblogger.com/next-bubble-to-collapse-the-canadian-housing-market/

    • says

      The rates are still low overall, so unless we enter a new era of lower rates, I think it’s still a bit too early to treat this as a long-term normal. With all of the debt at hand though, the BoC has to tread carefully!

  3. Tiny Potato says

    I don’t see a justification for a continued run up in prices. All the standard ratios are already way out of whack. Here in Vancouver, the CAP rates on condos are so low, pretty soon the owners will essentially have to pay people to live in the condos (j/k).

    The biggest impact in my opinion will be a change in people’s perceptions or, in other words, the pyschology of the market. The runup, particularly in Vancouver, has been such self fulfilling prophecy that people have lost sight of reason and most have never experienced a downturn. I think we’re at a very interesting point in time right now, with the prices stabilizing and sales volumes dropping, it will be interesting to see how people react. All the usual reasons for infinite increases (asian buyers, running out of land, it’s different in Vancouver) will be put to the test.

    • says

      I wonder how recourse loans affect things up here. People don’t like taking losses, and as the loans are recourse, that loss could mean their entire savings. Prices can’t go down if people are unwilling to sell, so what happens then? You end up with a bunch of zombies refusing to sell, and people stuck renting because they are unwilling to buy at current prices?

      Even if there is no bubble burst, if the market price is far from equilibrium, it can still be a drag on things. New construction would alleviate that, but IIRC Vancouver is pressed for land… it will be interesting to see how things play out!

  4. says

    Yes, I thought that Canada avoided most of the housing crunch because you never loosened the lending standards to accommodate the boom. It appears that the fiscal restraint has paid off handsomely, no?

    • says

      Hey Watson,

      Thing is, you have houses costing $400,000+ in the major cities, and upwards of $1,000,000 in Vancouver. Condos are costing $250,000+ in the major cities. The only way out from these prices are to live at the edges of cities (in which case you will still pay a lot of money: $200,000+ for a house) or to live in older or rundown areas (i.e., a 1970s apartment converted to a condo for $150,000).

      Given that Canadian gross incomes are similar to American incomes, but our net incomes are likely much lower due to ~13-14% sales tax, higher income taxes, higher price for goods, etc…. housing is that much more expensive for us.

      We’ve had the boom, we’ve just had no corresponding crunch. We’re stuck with high prices that feel good for old boomers, but put younger people in a ton of debt. You can obviously tell which group I belong to 😉

      • says

        Just as an example of how prices have gone up, I remember my grandmother buying a house in the late 1990s for about $70k. She sold it a few years later for about $100k or maybe a bit more. It’s now worth well north of $200k. I don’t think incomes have had the same kind of jump 😛

        Not saying there will necessarily be a bubble bursting, but we could just as well enter a “zombie” state, especially if rates go up and people spend huge amounts of their income on servicing debt. If housing prices don’t come down in nominal terms, then for the housing market to become more affordable, they need to come down in real terms (inflation), or income needs to rise in real terms.

  5. says

    Thanks for the mention!

    I believe the prices will correct themselves slightly downwards and stay relatively flat over a period of time with some regions having more or less an impact. For those on a fixed rate mortgage, the impact will be felt a number of years later and maybe not … Not too many people break their mortgage to take advantage of lower rates. I feel that when their mortgage comes up for renewal, the rates will be back to where they where for them. I can’t speak for all the new variable rate customers though but hopefully, they have a handle on their finance to handle higher rates in the coming years.

    I like your ‘zombie’ state analogy. Now, if only mortgage broker fees could be adjusted downward. The cost based on higher house prices is not justified for me … I am out of the market but I have found the fees obscene!


  6. says

    I hope we’re in a bubble, especially here in Vancouver. Most houses in Vancouver West have doubled in price in the past five years. For a house that was $800K, it is now worth $1.7 million. Its ridonkulous, I tell ya! =)

  7. Mike says

    Hey Kevin,

    Agreed that using income multiples for housing are the best way to see where housing prices are value wise. Another good indicator is 100-130 x the monthly rent for a comparable home. As we all know, housing prices can only be supported longer term by real incomes. A lot of people are still looking at appraisal values from a couple 3 ago (in the US) and they are pretty much meaningless. Another reason the appraisals are meaningless is that only (approximately) 25% of the loan programs that were available 2-3 years ago exist today. Ultimately, IMO, home prices will go back to the above and then track real wages. Regardless, I don’t think being “house poor” does anyone any good!

    Have a great weekend. Mike

  8. says

    Kevin, Are you reading my mind? I have been worrying about what will happen to housing affordability with a rise in interest rates. Rates are at historical lows and they are bound to rise. So many will be shut out of the market when rates rise.
    Thanks for the mention!

  9. Flupbuilied says

    I apologize for stupid question and if I ask is not where necessary. I do not understand, Kim Karadashian tape that all keep talking about – is really Kim K.?