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I received a message from a reader recently telling me “Check this out! The housing crash has officially started!”
They linked me to a news article about the plight of condo investors in Toronto. I know, I know, cry me a river, right? Well, take a read…
Ujjwal Jain never thought when he bought his pre-construction condo in April 2020 that it would cost him his life savings.
As the date for him to take possession of the condo nears, the bank appraisal, which is done to ensure the current market value of a property is in line with the size of the mortgage loan, determined the unit is worth $150,000 less than what he agreed to pay for it two years ago, before shovels were in the ground.
“How am I supposed to close the transaction? Appraisals are coming in so low, people don’t have $100,000 to $200,000. I have had friends who have had to declare bankruptcy, and I am in the same boat,” Jain said.Developers are hitting the brakes. Pandemic buyers are panicked as appraisals come up short. Is this the end of Toronto’s condo mania?, TheStar.com
In every bubble that pops, whether it’s real estate, Dutch tulip bulbs, or Beanie Babies, there’s always the last few idiots who buy into the frenzy with the absolute worst timing, right at the top of the market convinced that the insane, unsustainable run-up that they’ve sat on the sidelines watching will continue forever. Finally convinced that they’d be missing out on the easy money seemingly everyone else was making by sitting out, they go all-in. These are the people who make their moves right as the bubble pops, and are wiped out the hardest. That’s this guy, unfortunately.
The fact that higher interest rates is crashing the housing market is no longer a debate. It’s already started. While the crash won’t be even across the country, we can expect that the areas that will crash the hardest are the ones that ran up in price the most, which is what we’re seeing. Here in Toronto, the average price has already gone down about 15% YTD and economists are predicting the total damage will be more than 30% by next year.
So that begs the question: Is it finally Canada’s turn to experience our own version of 2008-style housing meltdown like what happened the US?
There’s a saying that history rarely repeats, but it often rhymes. The factors that lead up to each economic downturn are different each time, but when compared to previous similar economic downturns, we can often see some of these factors lining up. The more we see, the more likely the outcome will be the same. So how many factors do we see lining up in Canada right now that were present in the US at the beginning of their market meltdown?
Well, let’s see.
Overvalued Housing Market
Does Canada have an overvalued housing market? Ha! More like “When has Canada’s housing market not been overvalued?”
It was overvalued 10 years ago, when Kristy and I went housing shopping for the first time. We couldn’t believe how overpriced housing was back then, and disgust at the real estate market was one of the reasons why we decided to go down the FIRE path to begin with.
And that was 2012. Back then, the “crazily overpriced” houses that sent us running for the hills were $500k. Now? I don’t even know how to describe how overvalued our real estate market is now.
Fortunately, the OECD did it for us, naming Canada as the most overvalued housing market in the G7 in 2022, and the 2nd most overvalued amongst all advanced economies, behind only The Netherlands.
Nearly all advanced economies have seen home prices soar, but not like Canada. Only one other country has a faster growing disconnect, and it’s a tiny economy. Almost 3 dozen other developed economies are lagging, which is good news for them.Canada Has The Second Most Overvalued Real Estate of Any Advanced Economy, BetterDwelling.com
So do we have this condition of the 2008 crisis here in Canada right now? The answer is a resounding yes.
Rising Borrowing Costs
Every bubble popping requires a trigger. In 2008, the trigger in the US was the low teaser rates on adjustable rate mortgages expiring. This caused a sudden rise in borrowing costs, which meant people’s mortgage payments suddenly increased, which caused them to go go into default, which set off the entire foreclosure crisis.
Do we have suddenly rising borrowing costs here in Canada? Absolutely.
Canada’s central bank, like pretty much every other advanced economy, has been spiking their interest rates up in an effort to combat inflation. This has caused mortgage rates that had been sitting at 2-3% for a fixed 5-year term pre-pandemic to double to 5-6%.
However, this hasn’t affected the pocketbooks of most home owners. Yet.
In the US, when they call a mortgage fixed, the interest rate is actually fixed, in that they don’t change at all for the entire amortization. In Canada, however, a “fixed” mortgage’s interest rates is fixed for only a portion of the entire mortgage amortization, typically in 5 year terms. This means that in a rising interest rate environment, fixed mortgages are protected from ballooning payments but only until that term is up. After that, the mortgage renews for a new term at whatever the prevailing interest rates are.
That means that while people who already have a fixed mortgage aren’t going to see their payments increase yet, they will. In the next few years, more and more of Canada’s mortgages will renew at double the rate they’re paying now. The trigger is coming, but unlike in the US where it happened at all once, the pain will be spread over a 5 year period as households gradually renew.
Lax Lending Standards
Another major contributing factor to the 2008 crisis was the presence of NINJA loans, which stood for no income, no job, no assets and refers to the then-common US practice of giving out loans to people without verifying they had the means to, you know, pay the damned loan.
Fortunately, this is something we never imported to Canada. Even as the real estate industry here demanded that the financial regulators drop their lending standards during the pandemic, our government ignored them, instead implementing a stress test requiring borrowers to qualify at a rate higher than what the bank posted to make sure they could withstand a rise in borrowing costs without defaulting.
I was initially alarmed when I read this article, because it initially seemed like banks had been too easy in writing loans to investors. But upon closer reading, it turns out the issue is that the banks were actually refusing to go through with the loan after initially pre-approving him. The banks were actually acting responsibly and not writing the bad loans. That meant throwing the investor under the bus and leaving him facing bankruptcy, but quite frankly, who cares if he loses money? He took the risk, the risk didn’t pay off, so he has to pay the price. That’s how investing works.
As long as our banks don’t succumb to the siren song of deregulation like in the US and remain committed to not handing idiots rope to hang themselves with, we might be OK.
Contracting Job Market
While rising rates were the trigger of 2008, a contracting job market was the catalyst that turned that spark into a forest fire. When your mortgage payment suddenly doubles, you’d better not lose your job or bad things are going to happen.
This is where we have some good timing on our side. The job market here in Canada is still expanding. By quite a lot.
The Canadian economy added 108,000 jobs in October, reversing much of the losses observed in recent months and surprising forecasters who were expecting a very modest bump in employment.Canadian economy added 108K positions in October in ‘blowout’ jobs report, GlobalNews.com
This is a really important difference. Housing crashes have happened all throughout history, but what made 2008 such a cataclysmic event is that the damage from falling housing prices infected the banks as a wave of foreclosures overwhelmed their balance sheets what red ink. That made job losses even worse, which perpetuated the cycle of doom.
But if the job market remains healthy, that cycle of doom never stats. Even if houses plummet in value here, everybody’s underwater on their mortgages, and mortgage payments increase, as long as people keep their jobs, then the drop of housing values remains only a real estate market problem and doesn’t infect the broader economy.
And while it’s falling home prices and job losses usually go hand-in-hand, this time it’s the opposite. House prices are going down as the economy is stilling recovering from the after effects of the pandemic. That combination is actually pretty unusual, and could be a big reason why Canada avoids a fully-blown 2008-style meltdown.
So while I still think housing prices in Canada will continue to fall, and that many home owners (especially those that bought in the past year) are going to be in for a protracted period of losing money, the conditions for a wider 2008-style conflagration that burns down the rest of the economy with it aren’t there. Yet.
The bank of Canada has an incredibly delicate balancing act that I don’t envy at all. If they hike interest rates too slowly, inflation won’t be contained. But hike too fast and they might trigger the job losses that make a meltdown happen. And either way, they get yelled at by half the country no matter what they do.
What do you think? Is Canada headed for a 2008-style housing crash, or do you think the housing slump will be a more milder version? Let’s hear it in the comments below!
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