Thoughts on Canadian Housing

There's a lot to talk about these days. One subject that is often discussed here in Canada is our housing market and whether it is in a bubble. As a recent home buyer this is something I that I've been paying attention to. I came across a 50 page report by Alexandre Pestov who went to school at Schulich School of Business which happens to be where I went. He argues the housing market is in a bubble that's about to burst. I didn't go through the entire 50 pages, but something that caught my eye which made me snicker was when he discussed housing affordability as measured by the % of household income taken up by ownership costs. In his report he touches upon the previous major peak of the housing market which occurred in 1990 and says

The poor affordability during the last bubble was experienced not as much due to inflated housing prices, but rather due to high borrowing costs. .

This is a very important point which I agree with. If you look at real estate downturns in the past most of them are triggered by a sustainted period of rising borrowing costs i.e. rising mortgage rates.

The author then goes on to say

To level the field and understand how today‟s real-estate prices compare to those of the late 80‟s bubble, it is necessary to adjust the affordability measure for mortgage rates.

This guy goes on to adjust current 5 year mortgage rate to 1990 levels which were 115% higher than they are now to come up with an "adjusted affordability" measure. By those measures housing affordability becomes just as poor as it was at the peak of the last major bubble in 1990. I have one word for this analysis...idiotic. Where does he get this notion that 5 yr. mortgage rates are going to jump 115% anytime soon? I realize that a normalized mortgage rate is higher than present levels but to use 1990 as a benchmark is just plain dumb and/or shows a bearish bias. Even if we are on the secular path of higher interest rates from this point on (which we're probably not) it would likely take at least a couple of decades for rates to go back to 1990 levels. The last time rates where at current levels was in the 1940s. It took over 30 years before they doubled from their low point.

This guy's analysis is an example of making the data fit your thesis instead doing it the other way around like you should. But one thing this idiotic analysis proves is that it would take an unrealistic spike in mortgage rates before housing in Canada was as unaffordable as it was at the last major peak which argues the "bubble" is not in danger of busting anytime soon like he thinks.

I'm not saying that housing in Canada is cheap right now...it's not but if you look previous real estate downturns they are triggered by 2 factors. 1) A trend of higher mortgage rates for at least 1 year and 2) weakening employment conditions. We are not seeing those conditions right now.


Remember what I said about cutting through the bullshit and focus on what really counts? You can talk about how the ascent in housing prices has been too high or too much too soon until you are blue in the face and you can show me ratios and statistics all you want but the fact of the matter is that it all boils down to 2 things: mortgage rates and employment trends and it's the former that tends to matter the most. But when you are dealing with certain areas that have a high concentration of employment in any one sector employment trends are probably just as or even more important. Alberta for example is highly dependent on the fate of oil and gas.

Look, there WILL eventually be a housing downturn but it won't happen just because some ratio hits a certain level just like how a stock doesn't turn down when it hits some magic p/e ratio. History shows we would have to see a significant and sustained rise in mortgage rates in Canada before the "bubble" pops. I'm not sure what that rate is but it's probably a lot higher than present levels and so it will take a while before we get there.

A real estate bust in Canada occurring during the early stages of an economic recovery with mortgage rates still very low is a very low probability event....such a thing has NEVER happened. As mentioned before, real estate downturns happen after rates have climbed significantly for a while and that typically happens towards the end of an economic expansion not the beginning! Real estate downturns become crashes when prior to the peak there was reckless activity such as what we saw in the US with the subprime, liar loans, ect. Canada hasn't engaged in such reckless activity.


I remember back in 2002 people would be talking about a housing bubble in the US. During the 2001 recession housing prices dipped ever so slightly before making new highs as low interest rates enticed buyers. Housing prices in the US peaked in the summer of 2005, 3 years after all the bubble talk first started. By that time people had become desensitized about the notion of a bubble and accepted prices as being permanently elevated. We are not at stage yet here in Canada. Even if we are indeed seeing a bubble in real estate, the fact that so many people are talking about it indicates it's not going to burst anytime soon because we haven't reached the desensitized stage yet.

The Canadian government has put in place new measures to discourage speculative activity by investors and stricter lending standards for mortgage applicants. They too are concerned about a bubble forming even though they don't admit it. All I can say is that I have never seen a bubble burst when so many people are worried about it. When enough people drop their guard then it will.

I might sound biased because my wife and I just recently bought a home. However, we are in a good situation because to buy our home we sold our condo for a $100,000 profit after agent fees and closing costs. So even if our new home drops 20% in value we are still ahead of the game. I was well aware of the "bubble" situation before buying but we are in a position whereby we would be able and willing to live in our new home forever if need be making any real estate downturn a non-issue for us.

This is the advice I give my friends who ask me about real estate...if you can afford to buy a home (assuming a higher interest rate than now) and be able to live in it indefinitely if a downturn were to happen then go for it. If not, then rent. Pretty simple. If we do see this "bubble" burst its likely not going to happen for at least another 2-3 years and by then prices will be higher.

Trying to time the real estate market like the stock market is generally not a good idea. If for example you own a home and you expect a crash you might be tempted to sell it and rent for a year or 2. The problem with this strategy is that real estate is not nearly as liquid as stocks are and by the time you take into account the agent fees, closing expenses, ect, you out of pocket 5-8% of your selling price and then you have to go through it all over again (less the agent fees) when you buy back. And what if you get it wrong?