Is Canada in the midst of a housing bubble?

February 5, 2010

By Mark Milke
Research Director
Frontier Centre for Public Policy

Mark Milke
Mark Milke

CALGARY, AB, Feb. 5, 2010/ — Is Canada in the midst of a housing bubble? The Bank of Canada doesn’t yet think so. In his recent speech on behalf of the central bank, deputy governor Timothy Lane mostly downplayed the possibility that house prices in Canada are at dangerous, bubble-like levels.

As to why, Lane noted that, between 2000 and 2006, U.S. house prices appreciated by nearly twice as much as did Canadian home prices. As well, 2009 housing starts in Canada dropped to just 118,500, down from the 175,000 the bank thinks is the needed, long-run sustainable average. Thus, in Canada, there was never the overinvestment in housing stock that characterized the U.S. glut. (Think of overbuilt Miami and Las Vegas as prime American examples.)

And there were other reasons offered in defence of the no-bubble theory: Canada’s mortgage credit culture is more conservative, and a far smaller portion of the mortgage market is securitized, thus many lenders are directly on the hook for soured home loans.

A few caveats, however

The deputy governor did add a few caveats: Canadian home prices continued to appreciate for a longer period and household debt-to-income levels have hit a record 142 per cent.

But according to the bank the fundamentals are not out of whack. As Lane noted in the written portion of his remarks: “Recent house price increases do not appear to be out of line with the underlying supply/demand fundamentals,” pointing to how low interest rates have increased sales. This means, according to the bank’s deputy governor, that it’s “premature” to talk about a bubble.

Well, perhaps. But, as Lane pointed out, once the recession hit, and compared to their peak, average resale home prices across Canada dropped by nine per cent and new home prices dropped by 3.5 per cent.

Frankly, that’s not much compared with past recessions. And many markets, especially in the West, shot up again to almost their previous peaks. So I’m not as sanguine as the bank. Some markets in particular seem ripe for a sharper correction.

Consider Kelowna, a desirable place to work, live and retire, but where, with condominiums at least, the city appears massively overbuilt.

Drive around the central Okanagan city and you get a sense that every developer aimed for the high-end market. That’s problematic, given that not everyone can afford a high-end condo. And some who can, such as winter snowbirds, can now choose from an inventory of much cheaper product in the United States.

That doesn’t mean Kelowna’s market won’t come back (it already has, somewhat). But no one should overestimate the possible short-term hit real estate prices might take on the condo side, especially in places where outside investors drove much of pre-recession price spikes.

More generally, desirable markets like Greater Vancouver might more readily withstand an anaemic Canadian economy that crawls rather than races to recovery, given its scarcity in land coupled with migration and ongoing demand. Similarly, Calgary might squeak out OK if oil stays above $60 or $70 a barrel.

But when Canadians are in debt up to their fiscal eyeballs on the basis of low interest rates, another economic shock then becomes a problem.

Two risks

This is where the Canada-doesn’t-have-a-housing-bubble claim ignores at least two significant risk factor.

First, insofar as the economy recovers and interest rates rise (as they must in that scenario), or if government borrowing leads to an interest rate spike, the demand for housing will decrease, perhaps dramatically depending on the magnitude of the increase. In line with that scenario, if the rate increases are substantial over the next five years, some over-leveraged homeowners will be in a pickle. The claimed non-bubble may well start to look pricked.

Second, and alternatively, it is possible interest rates will stay low. But if that happens, the reason for continued bargain rates also doesn’t support the house-prices-will-stay-up theory. Maybe interest rates will stay low due to a double-dip recession, something entirely possible given continued U.S. weakness. Or consider the possibility China has been over-stimulating its own economy, and its own property price bubbles pop.

In that scenario, should the strength of the world economy falter, ask yourself what then happens to Western Canada’s resource economy?

And then ask yourself what happens to house prices.

Channels: The Calgary Herald, January 31, the Calgary Beacon, February 9. Canada Free Press, February 14, 2010

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