Two Ways to View Canadian Housing: Bubble & Bubbler
Canadas’ smartest number-crunchers have long known that residential housing prices are inflated. From June 2011:
“Canada is losing its penchant for wealth accumulation…In late 2006 Canada’s debt-to-income ratio and debt-to-assets ratios stood at 121.3% and 16.2% respectively. These ratios have gradually risen to 153% and 20%. In more absolute terms, total household debt has risen from $1 trillion in 2006 to $1.51 trillion by 2011.” (3,5)
The Anecdote Cuts Deep
Garth Turner (1) laments the greater fool who waits in a frigid parking lot overnight to sign purchase agreements for maddeningly overpriced, unformed slabs of land and arranged bricks for over $700,000CAD (roughly 10-15x after-tax household income for this area.(2))
“…on lots as skinny as 32ft, in a distant suburb of Toronto. The event was remarkable for the thronging, the pushing, the instant buying and the palpable desperation. “It was like everybody was crazy anxious when they got in,” one player told me. “Little women were bodychecking me to get a red dot stuck on a map square. Unbelievable.””
Ravenous buyers are readily exchanging real dollars (mostly borrowed against future earnings) for homes that are merely blueprints. The attitude of the mob has shifted into a dubious phase in Canada: euphoria. At their own peril potential home owners are signing away years of their life on a whim, lifted by a cresting wave of loose credit in Canada.
Mr. Turner evokes an apt analogy to Canadian horror stories Nortel & Bre-X:
“The crowd comes to a collective decision, and then free will is lost. Almost always, the crowd gets it wrong.”
Of course the prose of journalists may be persuasive, so we look to data courtesy of a Bank of Canada 2012 Special Report (3) and others.
The Pictures are Loud
Levels of household debt in Canada have trended upwards for 30 years. Most troubling is the vulnerability of First Time buyers who are loaded up with debt. The mean real debt load of a typical household led by people aged 31-35 is $120,000 up from $75,000 in 1999 (60% increase). The characteristics of their borrowing is frightening: slim equity margins (5-10% down payments) and tight servicing/coverage ratios (40% pre-tax income allocated to paying housing costs). Nothing sums up this jargon quiet like:
Numerically most of the credit bubble in Canada is due to mortgages used for residential housing, but a large component is ‘cash-flow lending’ where lifestyle is being supported with easy access to cheap credit. In Canada this credit is most commonly is delivered with potentially toxic consequences via access to Home Equity Lines of Credit (HELOC). These ‘gateway loans’ are like marijuana: smart and safe when used responsibly, but ruinous if abused by the wrong individuals.
While borrowers claim to be modernizing their homes through renovations, the data untangles the yarn they have spun to lenders. The BoC estimates about ~4.25% of total consumption is attributable to home equity extraction. HELOCs are being used for many purposes (shown above), with the smallest quotient being dedicated to renovations and non-financial investment. Clearly the borrowers are calling an audible at the line of scrimmage: instead of converting home equity into productive assets, consumption and debt consolidation takes the lions share of the past 10-years worth of home equity extraction in Canada.
A Pound of Flesh
What lurks around the corner during any subtle correction in the Canadian economy is pain and financial stress for many households that are over-leveraged, cash-poor and “house-rich”. Living off home equity is yesteryears’ dream and todays’ nightmare.
Based on 2009+2010 averages, consumption accounts for about 58% of overall Canadian GDP(4). BoC then calculates that a housing shock could reduce aggregate consumption between 1.3–3.1%, which loosely translates into a GDP drop of 1% for every 10% drop in housing prices.
My advice is to stay nimble and unencumbered by debt for anyone with budget concerns. There is a small subset of Canadians who can justify purchasing a home in this environment:
- cash flow strong (1 standard deviation above median household income)
- expanding their family
- plan on staying in the same domicile for at least 10 years.
To those unqualified to join this exclusive group, check out the price for rentals. Sooner than one might think newly-built condo units will be had for a song in a neighbourhood near you.
1. Garth Turner – “Crazy Anxious” http://www.greaterfool.ca/2012/02/22/crazy-anxious/
2. Statistics Canada – “Average income after tax by economic family types (2005 to 2009)” http://www40.statcan.gc.ca/l01/cst01/famil21a-eng.htm
3. Bank of Canada 2012 Special Issue: “Household Finances and Financial Stability” – www.bankofcanada.ca/2012/02/publications/periodicals/boc-review-winter-2011-2012/
4. Trading Economics – “Household final consumption expenditure; etc. (% of GDP) in Canada” http://www.tradingeconomics.com/canada/household-final-consumption-expenditure-etc-percent-of-gdp-wb-data.html
5. CGA (Certified General Accountants) – “A Driving Force No More: Have Canadian Consumers Reached Their Limits?” http://www.cga-canada.org/en-ca/ResearchAndAdvocacy/AreasofInterest/DebtandConsumption/Pages/ca_debt_default.aspx