Canada's Housing Bubble

Just like Americans, Canadians are a very, very optimistically biased society. Look - you can have a conversation about a housing bubble in Great Britain, and they'll say 'oh is that right? Let me see the data'. If you have one in Canada it's World War 3. They hate you! They hate you for years! 

So let's put our biases aside and take a look at some data.

So what is the Canadian housing bubble? 

Simply put it's an unprecedented rise in real estate prices!

The average home price in Canada increased by 137% since 2000. 

Steep increases in price can be observed in every province:

Saskatchewan                                        Alberta

 Nova Scotia                                   Newfoundland

British Columbia                                    Ontario

Manitoba                                     New Brunswick

Quebec                                                     PEI

And in every major city:

Calgary                                            Winnipeg

 Edmonton                                       Gatineau

 Halifax                                                Hamilton

 Oshawa                                             Montreal

 London                                              Kitchener

 Kingston                                             Ottawa

 Quebec                                                Regina

 Saguenay                                             Saint John

 Sudbury                                           St.John's

 St. Catharines                                        Sherbrooke

  Saskatoon                                     Thunder Bay

     Toronto                                         Trois Rivieres

 Vancouver                                       Victoria

Realize that housing booms and busts have occurred before. But those cycles were hidden from plain sight due to inflation.

Measuring home prices without adjusting for inflation is like measuring the length of a pen with a ruler that constantly shrinks or expands. Thus it is important to adjust real estate data for inflation to see the true value of dwellings over time. And I did just that:

Now you may say that the increase in home prices does not necessarily equate to a housing bubble. And you would be right.

Housing bubbles occur when home prices rise significantly faster than the underlying fundamentals. 

You can read the full list of fundamentals here. Below I will focus on long term anchors of property prices.

One such anchor is income.

The story of income growth in Canada can be summarized by one word and one word only - stagnation. 

Between 1980 and 2011, home prices in Canada have doubled (adjusted for inflation) while incomes remain the same. If you graph incomes versus real estate prices you would get the following graph:

According to TD, Deutsche, OECD, and IMF home prices in Canada are overvalued against incomes by as much as 32%. 

Another anchor of property prices is the relationship between home prices and rents. 

Against rents Canadian real estate is overvalued anywhere between 60% to 88%. 

But how about the interest rates? After all mortgage rates have been falling for over three decades now. 

You might be surprised but interest rates are not the main driver of real estate prices. In the long term there is no significant correlation between home prices and interest rates. 

Furthermore, if you were to believe that interest rates drive property prices than you must also assume that if interest rates rise then housing prices will fall. 

What really drives home prices is society's perception of where the prices are heading. The history of past price growth reinforces future price appreciation. 

Bubble thinking means thinking that the trend in prices will continue. 

But don't get me wrong - low interest rates inflated this bubble further than it would have otherwise, hence the record debt levels and very low debt service ratio.

CMHC certainly played a role as well:

Question is, what will happen when the interest rates inevitably rise! Perhaps the next chart might give you a clue.

Just like home prices, the average household mortgage in Canada significantly increased.

Furthermore, since 2000 home renovations replaced hockey as the new national sport. Canadians started competing against each other for best looking granite counter top and most expensive kitchen.

But with stagnant incomes how did Canadians manage to finance all those renovations? 

In sum, just like everyone else, Canadians fell in love with real estate. What a waste of money! Instead of investing in a house of cards we should have invested money in R&D and manufacturing instead of making the FIRE (finance, insurance and real estate) industry the largest industry in the country. Once Canadian housing enters a bear market so will the economy!

Finally let's conclude by comparing the Canadian housing bubble to the one that happened in the United States. 

Notes:
- this article is a work in progress and much more content will be added later
- all the graphs will be updated on quarterly basis
- the opening paragraph was me paraphrasing Jeremy Grantham

If you have suggestions of what to add to this article leave a comment below. I want to make this page a summary of Canada's housing bubble. So please criticize constructively. Thanks!