Talking about Canadian Real Estate has always been a contentious point for me. I certainly do not want to leave the impression that I have not participated because most people who know me know full well that I have been an active participant.
Here is an excellent "break-the-ice" fact. I now have about 700 connections on the almighty Facebook. Of 700, more than 200 are involved in real estate, by my count, either directly or indirectly. That means roughly 28%, maybe more, are in real estate or real estate speculation. And these are of the ones I know. That is incredibly alarming!
What Data Do We Have?
So why do I bring this topic up now? What are the valid talking points of this subject matter? Well, for one, we know nothing about Canadian Real Estate except the asking prices themselves, which seemingly is the only thing that matters, right?
What if Canadian home prices unexpectedly tumbled by 20 percent? What percentage of homeowners would be at risk of foreclosure? We do not know.
What if interest rates rose by one or two percent? How many Canadians would be too overextended to make their monthly mortgage payments? We do not know.
Can we honestly say right now that there is anything analysts, policymakers, lenders, and borrowers could do differently to shield Canadians and the economy against a crash, or at least prevent worsening one? We do not know.
There is an enormous void of official government data on everything housing-related. We do not have readily available access to:
Average down payments,
Average monthly mortgage payments.
Number of dwellings owned by foreign investors.
Number of homes meant for speculation vs primary dwelling.
Number of homes currently empty being held only for equity gains.
The Global Warning
There is a scarcity of factual data on the financial position of Canadian homeowners and mortgages. This scarcity has left those who study the mortgage market functioning in a dark realm with little or no direction.
For several years now, Canada's housing market has been the strongest performing developed market, making it the world's most overvalued, according to The Economist, the OECD, and Deutsche Bank.
Moreover, numerous publications are now reporting Canada's housing market as one of the most overvalued in the world:
Two Sides To Every Story
To be fair, this has been ongoing for some time. In 2016 I wrote that the "Deutsche Bank published their house-price-to-rent index, and it showed that Canada has the most expensive housing market in the world; as much as 60% over-valued..." and that was way back in 2016.
So I do concede on the notion that every story has two sides to it. The other side of this argument is that house prices in Canada have rallied far longer than I thought they would. Many investors, and homeowners, have made handsome returns.
I will also acknowledge that I believe prices are going to trend higher. They will most likely do so into the middle of at least 2021 as the spring unleashes even more pent-up demand from crazy house-horny speculators trying to grab that last dollar, lake view or rural compound to practice their yoga and "peletoning." So yes, I recognize the other side of the argument but let us go a step further.
It Is Getting Frothy At The Top and The Satanic Green Phlegm
Industry observers have portended for years that the market is heading for a significant drop, that the levels of borrowing and continually rising home prices are untenable. But so far, they have been mistaken as prices continue to grow.
However, incomes continue to stagnate, and now Covid is leaving a path of destruction that, on paper at least, has left us with a 9.4% unemployment rate. NO more concerts, Air BnB, Leaf Games, Baseball Games, Raptors games, shows, retail, eating out, airline, hotels, tourism and travel. Now there are warning signs of contraction from GDP to shrinking renters in the GTA. From insolvencies and small business failures to the maintenance of low-interest rates for the economy's sake, even though bond prices tell us mortgage rates are about to go higher.
All of these points go hand in hand as we realize that paper headlines like the 9.4% unemployment rate are more likely to be well into double digits in reality. Bankruptcies will number thousands upon tens of thousands wiping out many small towns' local business infrastructure. That work from home was no the miracle serum for higher productivity it was so optimistically thought to be.
With no end in sight to either rising home prices or this little green Satanic phlegm, conflicting views of the market's health will continue to flourish. We are edging closer to some dire moment in market fluctuation that eats our wealth yet again for the second time in less than 15 years.
The Clock Is About To Strike Midnight – What The Data Truly Says
Unfortunately, almost every single housing market indicator is now in the danger zone when you do your homework. Based on historical cycles, we could be in the midst of the largest real estate bubble in Canadian history.
First of all, it is unfortunate, but true, that Canadians have never been in so much debt. To finance their home purchases, Canadians are turning to escalating amounts of very cheap debt. According to numbers compiled by Statistics Canada, household debt-to-disposable income hit a near-record amount of 170.7% in the third quarter of 2020, up from 162.8% in the second quarter of 2020.
We are approaching comparable levels to the United States in 2005, right before its real estate market buckled. Although Canadians are, during Covid at least, managing to lower their non-mortgage debt, overall debt loads are higher when factoring in mortgages.
In their last press release of November 2020, Equifax had this to say:
"Continued growth in the housing market and new auto loans led the way in driving total consumer debt up by 3.8 percent to $2.041 trillion in the third quarter, according to Equifax Canada's most recent report on consumer credit conditions. Overall average consumer debt rose to $74,897, up 3.3 percent compared to the third quarter of 2019.
Mortgage balances increased by 6.6 percent in contrast to Q3 of 2019, and the average new mortgage loan amount surpassed $300,000 for the first time, an increase of 8.6 percent."
In addition to this, the Canadian economy has never been so heavily weighted in real estate. Record low-interest rates have fundamentally restructured the Canadian economy. With the country's manufacturing sector battered, construction jobs have made up the for someof that loss. Thanks to a booming real estate market, some estimates peg 13-16 percent of Canadian employment linked in some way to construction. This is the highest level in over 40 years that this figure has been. If this figure reverts to the mean, which is roughly 7 percent, the job losses will be measured in the hundreds of thousands.
With this entire boom in real estate, we have heard much about the explosion in larger residences. More house size and larger properties have been so omnipresent that the gap between house prices and income is the third-worst in the developed world. Say it with me. "The gap between house prices and our income is the third-worst in the developed world."
Artificial Value Caused By Over Speculation And Artificially Low Interest Rates
Canadian real estate prices have outperformed income growth for well over a decade. In our parents' heydays, Canadians paid between 3 to 4 times their average annual income for a new home. But today, that figure has ballooned to almost an average of 9 times yearly salaries. This is one of the most frightening variables and one reason why paying down your mortgage is still the best investment you can make. Instead, in this era of historically-low interest rates, many buyers have been taking on much bigger mortgages than they would be able to afford if rates were even a little higher.
When rates reset, and they will, overextended buyers could sink into insolvency. How many would be affected, and to what extent would this impact the market? We do not know. Because, yet again, the market data doesn't exist or is not getting shared with the public!
The country's top real estate scholars, and even the federal government themselves, continue to make decisions and draw conclusions from fractional information, surveys and circumstantial evidence, which in my humble opinion is NOT a practical way to continue.
We need simple statistics that would be useful for forecast, including data disclosing the average amount of a mortgage loan contrasted with household income, which could shed light on how much of our finances those mortgages are eating up. In addition to this I would also like to know:
More about those at high risk of default.
How many investors have high ratio mortgages (which are mortgages that carry less than 20 percent equity in the home).
What percentage of mortgages are being amortized over the maximum allowable period to prevent the owner from paying larger monthly payments.
Believe it or not, as simple as it sounds, this data does not exist or is not shared with the public.
If our government were ever to disclose data, such as the overall amount of equity in homes, it would reveal the strength of homeowners' financial positions and go a long way towards discovering how close we are to seeing the bubble burst.
Another significant concern spreading like our U.S. counterparts is the gap between house prices and rent. This gap is the second largest in the world. In a rush to become a homeowner, Canadians are paying record premiums for the privilege of buying a house. Today, the average residential home sells for 25-28 times annual rental income.
However, in major centers, such as Toronto and Vancouver, this figure is well more than 30 to 50 times rental income. Historically, Canadian real estate traded between 10 to 20 times rental incomes nationwide.
It actually means that many investors are making next to nothing in real income for their rental properties. Instead, they are speculating big time that the rise in the value of the home or condo will provide the majority of their speculative gain.
When a house sells in a few hours with multiple offers, I am proud of my colleagues' success. However, it reminds me that when rigged or unsubstantiated or even unknown numbers are the basis of our success, we have failed. If you look around and consider what is discussed in this article, you will see that the entire financial system in Canada is at risk with such high reliance on real estate.
The consequences of a housing correction would have a devastating set of penalties for the nation's banking sector. In the event of a recession, losses on uninsured residential loans could brutally damage the industry's capital supports. However, this is nothing new.
Back in 2013, Dan Werner of Morningstar projected that "In a worst-case scenario, if all of the uninsured loans were losses and residential prices fell 30 percent, we think nearly half of most banks' tangible equity would be affected." Werner thought back then that the National Bank of Canada and CIBC would be the most distressed of Canada's big banks. Banks with a larger international presence would be less affected. Imagine what it might be now!
I believe we have a right to this information and a personal belief that it is being kept from us on purpose to further pricing speculation. For the record, please remember that most of the above data is readily available in peer countries, such as Australia, the U.S. and others.
In the U.S., banks must report much more information. They have to report such statistics as service ratios (the amount of income put towards a home purchase) and loan-to-value ratios (the amount owed on a home compared to the amount spent). However, that information did not prevent the 2008 U.S. housing crash. But it provided comprehensive insight into what, exactly, was happening. This is a potentially valuable lesson for Canada because U.S. homeowners were warned that what was happening was not sustainable from about 2005 onward, just like we are warning about the Canadian market now.
How can we make crucial investment decisions when there is valuable data out there that is not shared? Canadian banks collect essential information such as the credit scores of high-risk mortgagors and exactly how much equity their clients have in their homes contrasted to how much they owe. But they decline to share it, even with their economists. Go ahead and ask any real estate agent for this data or your bank, for that matter. It will likely be a dead end.
Even the Canadian Mortgage and Housing Corporation (CMHC), the government arm held responsible for insuring high-risk borrowers, hides most of its collected mortgage market data. In contrast, its annual review of the housing market relies partly on a survey conducted by the mortgage industry itself. In this environment, most of the attention turns to the insufficient data industry associations choose to make public.
The Canadian Association of Accredited Mortgage Professionals' annual report contains useful data such as the average amortization periods and average mortgage interest rates. But it is based on a survey of just over 2000 Canadians, which is undoubtedly not enough.
Meanwhile, the most meticulously monitored metrics come from a monthly sales report by the Canadian Real Estate Association (CREA). The CREA is an organization with a mandate to promote the market's health and realtors' importance. It releases only the information it wants. It charges for a deeper dive into the market and holds back the rest.
In fact, the Toronto Real Estate board continues to be embattled in a legal fight over data despite a 2016 ruling that gave buyers and sellers the right to view far more data. Even my colleagues in the industry have told me how difficult it is to secure detailed information about the housing market as a whole.
Real-Time Data Is Needed
Buyers, analysts, sellers, economists etc., do not want month-old sales reports any more than they may want to know what a stock did last month. Still, if you could look at mortgage stats and levels of debt in real-time or at least within a few days of their occurrence, I think that would be a lot more beneficial in making significant forecasts about where the housing market is in a year from now.
Banks carefully track their mortgage statistics, such as clients' average debt service ratios and additional data that would be advantageous to analysts, but keep them extremely guarded. I can also tell you that upon talking to my clients who work for banks that their employers carefully protect that data. Without all of this data, can you find anything that can help in the search to find out what the housing market is doing?
The answer is a partial yes, but you must be creative in your sources. You can pay for more in-depth access to some data, such as reports from the CMHC or CREA, but it's not cheap, and it becomes cost-prohibitive to the average home buyer or speculator. You can use your colleagues and their access to the Realtor listings database to find out information, but that could be compromising their ethics or legal boundaries.
There are other types of data, such as the Ipsos Reid household financial survey. It can give you a small look at debt service ratios, from which you might be able to estimate the share of households that would be most vulnerable to a rise in interest rates but nothing concrete.
Housing policy and data gathering are challenging because the federal government manages immigration and finance, the provincial government regulates land development, and municipalities determine zoning bylaws and collect property taxes.
Banks and additional types of lenders collect and submit a few bits of mortgage data to OSFI (Office of the Superintendent of Financial Institutions), the regulator for institutions that control some 80 percent of the lending market. OSFI "encourages" the big banks to be transparent but keeps their own details secret.
OSFI requires lenders to disclose the percentage of insured versus uninsured mortgages in their portfolios, a summary of the percentage of mortgages that fall within various amortization rates and the median loan-to-value ratios of uninsured mortgages.
The banks also report their average loan-to-value ratios (how much owed versus how much owned) for uninsured mortgages quarterly. Still, they are not required to do the same for insured mortgages, which often make up a majority of their mortgage portfolios.
However, researchers focus more on the financial position of borrowers who are insured because they tend to have less equity in their homes and have fewer savings for down payments. Since insurance is a requirement for anyone with a down payment of less than 20 percent, those figures would offer insight into dicier borrowers and go further to reveal the mortgage market's healthiness.
Maybe We Need To Be More Diversified?
Instead of knowing, without prejudice, all of the details about our housing industry, how can anyone continue speculating and hoping for the best? I refuse to do it, but this said, the truth is that not knowing means this evolution of sustained real estate growth and speculation could be done tomorrow. Or, it could roll on for years to come. I am personally not willing to risk my capital in that way. I am not suggesting it will be the best decision for you but perhaps give some attention to hedging your investments with something that has a 5000-year track record of protecting us during uncertain times, such as Gold and Silver.
I will continue to diversify my portfolio with quality, tangible hard assets that include, but are not limited to, physical Gold and Silver. They are not the only things I will use, but they are fundamentally undervalued compared to real estate and have a fraction of the investing public interested at this point. This alone makes for a beautiful, fundamentally driven long-term market, which I believe will provide results for investors for years to come.
Yours to the penny,
Darren V Long