Canada's Housing Bubble

> August 2010 Canada’s Housing Bubble An Accident Waiting to Happen David Macdonald Please make a donation... Help us continue to offer our publications free online. We make most of our publications available free on our website. Making a donation or taking out a membership will help us continue to provide people with access to our ideas and research free of charge. You can make a donation or become a member on-line at www.policyalternatives.ca. Or you can contact the National office at 613-563-1341 for more information. Suggested donation for this publication: $10 or what you can afford. isbn 978-1-926888-11-8 This report is available free of charge from the CCPA website at www.policyalternatives.ca. Printed copies may be ordered through the National Office for a $10 fee. 410-75 Albert Street, Ottawa, on k1p 5e7 tel 613-563-1341 fax 613-233-1458 email [email protected] www.policyalternatives.ca Canada’s Housing Bubble: An Accident Waiting to Happen Introduction down” requirements and shorter amortization periods for new mortgages. The Harper govern- Canadians are becoming increasingly concerned ment has not completely heeded the banks’ calls that, like our neighbours to the south, there may although it has made some changes.5 be a housing bubble in Canada. Given the central role housing affordability While the prospect of a bubble has been played in the U.S. financial crisis that sparked a downplayed by the Bank of Canada, a number global economic meltdown, it’s important to as- of economists have warned that Canada’s hous- sess what factors might be playing into a housing market is overvalued1, which is bankers’ ing bubble in Canada and the depth of the risk. conservative way of suggesting a housing bub- This report attempts to assess the risk in- ble may be afoot. herent in today’s housing market by comparing The CIBC warns a housing correction is in Canada with the U.S. on several key scores. It the cards, which is a milder alternative to a full- begins by describing the factors that feed into blown bubble bursting — though there are signs housing bubbles, drawing on the history of Ca- of trouble on the horizon.2 nadian housing bubbles to put things in context. For instance, the OECD finds Canada has the It looks at the rising price of housing in Canada, highest consumer debt to financial asset ratio especially post-2000. Then it creates three his- among 10 OECD countries, including the U.S.3 toric scenarios to test the size of the bubble and The Canadian Association of Accredited Mort- locate where it is occurring. gage Professionals estimate about 375,000 mortgage holders in Canada are already challenged What goes into a housing bubble? by their current payments and may not be able to handle higher rates.4 Housing bubbles have occurred in Canada but And, behind the scenes, Canada’s banks are they don’t happen every day, and they don’t hap- clearly concerned: This spring they asked the fed- pen automatically. eral government to legislate both higher “money Canada’s Housing Bubble 3 A housing bubble emerges when housing prices to an overvaluation of house prices, where a small increase more rapidly than inflation, household number of buyers drive the bidding on the best incomes, and economic growth. Several factors housing and trigger a price escalation in neigh- tend to contribute to the growth of a housing bub- bouring markets. This price contagion results ble: low mortgage rates, access to easy credit, net in a situation where the majority of consumers immigration and the stock of available housing. are bidding more on houses than they can really And, as witnessed in the U.S., wild card factors afford, in hopes of living in the neighbourhood such as sub-prime mortgage schemes in loose- they choose and/or investing in financial assets ly regulated financial markets can cause major for future economic security. damage to economies. Factors such as low mortgage rates and ac- Housing bubbles: A Canadian rarity cess to easy credit help draw buyers into a market they might otherwise not be able to compete in. Generally speaking, the bursting of housing Canadians haven’t seen mortgage rates this low bubbles is rare in Canada. There have been only in more than 50 years; the Bank of Canada over- three Canadian housing bubble bursts in only night rate has never been lower. While housing two cities — Vancouver and Toronto — since 1980. may be “affordable” based on record low rates, the Vancouver’s first housing bubble burst in 1981, affordability situation in Canada could change the second declined gradually in 1994. Toronto rapidly if mortgage rates return even part way had one housing bubble, which burst in 1989. to their historic norms. Otherwise, inflation-adjusted housing prices in However, low interest rates are only part of all major Canadian cities remained remarkably the picture. The number of new houses added, stable from 1980 until 2001. Since then, housing the changes in population, as well as income prices have been steadily rising to relatively new and inflation increases over time may also help and possibly troublesome heights. Take a look at to explain higher house prices. Figure 1. It plots average residential real estate This study examines the Canadian hous- prices since 1980. Few indicators rise so starkly ing market over the past 30 years and finds the and so steadily as the national average of hous- market is more unstable than it has been in over ing prices in Canada post-2000. a generation. Between 1980 and 2000, housing The graph shows two clear plateaus — one prices were relatively stable in Canada’s large for the early 1980s, with house prices at approx- urban centers, despite isolated bubbles in cities imately $75,000 and a second starting in 1989, such as Toronto and Vancouver. But since the with average prices at $150,000. It also shows early-2000s, the housing market has been on steadily rising prices in the 2000s. a steady climb and, in some cases, it exploded, However, looking at broad averages can be within the blink of an eye, especially when com- deceiving. Although Figure 1 displays a quite or- pared to historical norms. derly graph line, it has managed to conceal the The rising cost of housing is one of several three major price bubbles in Toronto and Van- red flags on the Canadian landscape. Household couver. It has also completely masked rapid, oil- incomes also play a role in creating housing bub- fuelled housing booms in Calgary and Edmonton. bles. If everyone’s income is rising in step, house Since it is usually one or two key markets, prices can rise without jeopardizing affordability. often Toronto or Vancouver, that drive nation- But if earnings of those at the top of the income al and regional house price averages, this report spectrum rise much faster than everyone else’s, drills down on housing trends in the six biggest as they have done in the past decade, it can lead markets in Canada: Vancouver6, Edmonton, Cal- 4 canadian centre for policy alternatives figure 1 Canadian Residential Real Estate Prices $400,000 $350,000 $300,000 $250,000 $200,000 $150,000 $100,000 $50,000 $0 1980 1982 1984 1986 1988 1990 1992 1994 1996 1998 2000 2002 2004 2006 2008 2010 sourCe CREA gary, Toronto7, Ottawa and Montreal. Together When you factor in median incomes, the same they represent approximately 40% of all real es- historic range appears for housing prices. Hous- tate sales in Canada.8 ing prices for 20 years, prior to 2000, stayed in a The graph below shows the average inflation- narrow range of between 3 and 4 times provincial adjusted housing prices in these cities between annual median income.10 Today, however, hous- 1980 and 2010, reflecting a more volatile mar- ing prices adjusted for income are out of their ket and registering a brief blip as recession hit historical range, costing 4.7 to 11.3 times Cana- Canada in 2008 as well as the market’s quick dians’ annual income.11 recovery. Canada’s housing market has shown As well as inflation and income, a variety remarkable resilience through the worldwide of other factors affect housing prices in a more economic downturn, quickly regaining ground short-term fashion. Economic growth (GDP) is in 2009–10 with possible price bubbles in sev- connected to incomes and so may be partially eral Canadian hot zones. represented in the income-adjusted housing Between 1980 and 2000, the historical price prices. Unemployment may be a better indica- range for housing in Canada stood pretty steady tor of potential home buyers’ economic reality. between $50,000 and $80,000 in inflation-ad- It is more volatile than GDP and, many times, justed 1980 dollars. But within a brief five-year GDP recovers while unemployment remains period, 2001–06, all major housing markets in stubbornly high. Canada shot to well above the $80,000 average Mortgage interest rates also have a signifi- price point that had been the norm for 20 years. cant bearing on house purchases: higher rates And just four years later, in 2010, the average may push some buyers out of the market if mort- price of housing in Canada’s cheapest markets gage carrying costs become too heavy a burden. topped $100,000 — twice as much as the hous- Down payment requirements and the cost of ing market floor historically. mortgage insurance may act as upfront impedi- Canada’s Housing Bubble 5 figure 2 Average Residential Housing Prices Adjusted for Inflation (1980$)9 $300,000 $250,000 Calgary Ottawa Edmonton Toronto Montreal Vancouver $200,000 $150,000 $100,000 $50,000 $0 1980 1982 1984 1986 1988 1990 1992 1994 1996 1998 2000 2002 2004 2006 2008 2010 sourCe CREA, GMREB MLS Barometer, StatsCan, Author’s Calculations ments, although these remained fairly constant age change in single family home sales in key until Canada ushered in more lenient mortgages U.S.

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