Concrete Analysis

Canada residential real estate looks risky, but it’s not everywhere

The residential sector is all fired up, but is it staring at a bubble and will it pop?

PUBLISHED : Tuesday, 17 May, 2016, 10:00pm
UPDATED : Tuesday, 17 May, 2016, 10:00pm

There has been much debate about whether the Canadian housing market is in a bubble, and if so when and where it may pop. Pundits on both sides of the debate are sparing no effort in putting forward their cases.

Even some Americans – investment analysts, investors, economists etc – have joined the fray. They mostly argue for a pop and recommend shorting the Canadian dollar.

The Yes camp generally cites the increasing Canadian household debt-to-income ratio, which seems to be a result of increased mortgage debts due to rising home prices.

In particular, some Americans are convinced that Canadians are again being too enthusiastic about real estate and borrowing too much to get a piece of it.

Indeed, the loose money policies embraced by central bankers worldwide are providing much of the needed fuel firing up the property market.

The No camp argues that Canadian banks are holding down the mortgage approval line well. That means subprime lending is almost non-existent and so avoiding the pop which befell the US before.

It could be said that lowering the Canadian dollar further could be a prop for property prices, although it may bring other, unintended, consequences.

If mortgage rates remain (historically) low, the real estate market might continue to survive or even thrive

But this still begs the question: is Canadian real estate bubbly and will it pop?

Not having a crystal ball, macro numbers can be collected and assessed to get a feel of the risk.

Most Canadians are perhaps aware of the two priciest provinces to own a home. Despite the cost, this does not mean their real estate is riskier than most, or more over-valued than most. The provinces contain two of the most populous cities in Canada and as such do not come cheap.

To ascertain whether a burst is down the road, an estimate has been made on the percentage of household income required to pay the mortgage.

Based on a 75 per cent mortgage payable over 30 years at 2.5 per cent and taking into account household income and income tax, there is not much to be concerned about – save for British Columbia where mortgage payments as a percentage of household income before tax stand at about 36 per cent. Post-tax, this rises to 49 per cent. Other provinces and territories appear reasonable.

Raising the mortgage rate to 5 per cent results in most places still offering reasonable percentages of household income, even after tax deductions. The exceptions are again British Columbia and Ontario.

Even before tax, practically half a household’s income pays the mortgage. This rises to two-thirds after tax. Ontario is slightly better at 32 per cent pre-tax and 42 per cent post-tax.

It is reported that Canadian homeowners have more home equity than real estate debt, though a normal distribution of equity and debt would imply that some, those who are younger or first-time buyers, would have equity of 10 per cent or less in their homes in the first few years. Any economic downturn might impact them more than other categories of households.

All this simply serves as “what ifs” for gauging risk in the Canadian housing market. Besides, household income can fluctuate too. From the above, it can be speculated that:

The mortgage rate trend is the key. If mortgage rates remain (historically) low, the real estate market might continue to survive or even thrive, but watch out for QE trends and changes, if any.

As a non-fan of quantitative easing – though it has helped boost Canadian property prices – it could lead to some big negative events worldwide;

The risk is there but not evenly distributed. British Columbia and Ontario occupy the first and second top risky spots, with the former a long way ahead.

Nonetheless, British Colombia – where Vancouver is dominant in scale – attracts comparatively more external investment capital resulting reportedly in certain sectors being flooded with cash.

The other provinces appear to be in tolerable range; and

Because one in three Canadians live in Ontario its economy matters more too. By some estimates, its share of national gross domestic product is about 37 per cent versus British Colombia’s 12 per cent. A home price collapse in Ontario will cause a bigger ripple across Canada.

So are there risks in Canada’s real estate market? Yes, but not everywhere and even where it exists it is not distributed evenly.

Stephen Chung is managing director of Zeppelin Real Estate Analysis and an honorary adjunct professor of the University of Hong Kong