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Sunday, April 10, 2011

Signs point to a severe housing correction in Canada

from ChaoticFate.com by qew
http://bit.ly/iizQLW



GEORGE ATHANASSAKOS | Columnist profile | E-mail


From Monday's Globe and Mail
Published 
Last updated 


The resilience of the Canadian housing market has confounded experts. While other property markets around the world have plunged, real estate prices in this country continue to reach new heights.
If the Canadian housing market does falter, the impact on the economy will be profound. Consumer spending and housing investment will feel the pain, and the Canadian Mortgage and Housing Corp., which provides mortgage loan insurance, will face substantial losses.


Some believe that low interest rates, solid banks, a growing economy, abundant natural resources and a relatively conservative mortgage market (at least compared to the United States) will all continue to support Canadian housing prices. Optimists argue that the runup in Canadian home prices has been based on strong demand from homeowners, while construction in the U.S. ran well ahead of actual demand and was fuelled by speculators.
But there’s another side to this debate. I believe that Canada’s high house prices in relation to incomes, combined with record household debt levels and overinvestment in residential construction, will cause a severe correction in the real estate market.
Home prices are simply way out of line, especially when viewed in relation to household income. The ratio of house prices to income has historically averaged about 3.5 in Canada. It now stands at about 5.5. It is difficult to see how income growth in the future can bring this ratio close to the historical average within any reasonable period – so it follows that house prices will have to decline.
Signs of stress are already evident, especially when you look at household debt levels. In recent years, the gap between house prices and income has been bridged through borrowing. The average Canadian family debt hit $100,000 in 2010. About 17,400 households are behind in their mortgage payments, representing an increase of nearly 50 per cent since the start of the last recession.
The current consensus is that Canada’s real estate market has achieved a “soft” landing and that prices will flat line but not decline substantially over the next several years. I disagree. The housing market in Canada is already in bubble territory. Average house prices have doubled in the last 10 years, while rents have risen by only about 30 per cent. The ratio of house prices to rent is now higher in Canada than in any other developed country.
An even more powerful indicator also points to a severe housing correction in Canada. Residential housing investment as a percentage of GDP was 6.48 per cent in 2009, down slightly from 6.76 per cent in 2008, after peaking at 7.13 per cent in 2007. The previous peaks were at 7.26 per cent in 1976 and 7.18 per cent in 1989 – and we know what happened to the housing market in Canada in the early 1980s and early 1990s. After residential housing investment as a percentage of GDP peaked in the previous two cycles, the housing market crashed within a few years.
I believe we are running out of time. By way of a comparison, this ratio peaked at about 6.1 per cent in the U.S. in the mid-2000s at the height of its housing bubble, and toward the end of the 1980s in Japan, when that country was nearing the end of its own property boom. Both countries experienced sharp declines in housing prices soon afterward. (I should mention that the ratio stands at 6.0 per cent in China at the end of 2010 – no wonder there is talk of a bubble in the Chinese housing market.)
Canada is past the point of no return. What has propped up the housing market in Canada and delayed the correction is artificial demand from Asian investors. While it is not clear when this demand will dry up, it eventually will. Once it does, watch out.
The ratio of residential investment to GDP has provided a powerful leading indicator of housing corrections around the world and in Canada during past cycles. The question is, why would it not work this time around? I am willing to listen.

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