An (updated) Warning & a few words

Thought the above scanned image from Charles Mackay’s 1841 print of Extraordinary Popular Delusions and the Madness of Crowds would be apt for this piece.

For those that personally know me, i am sound a lot like a broken record about now, as i have harped on about the Northern (Canadian) residential real estate market being distorted since at least 2012 (see here), so for those friends, acquaintances and skeptics alike who have not heard this before, i am going to play a “bubble card” and elucidate on a favorite topic once more for all to see – solely using organized, sourced facts and figures as per below:

– Base interest rates at all-time lows (have been so for close to past 8 years and counting now). Currently at 0.50% as i write this on Jan. 18, 2016, with the prospective of a further 25 basis point cut perhaps looming, thus perhaps helping perpetuate and exacerbate the madness even further.

– Median Canadian consumer debt-disposable income is currently 163.7% as of Dec. 31, 2015 or better said “the avg. person owes approx. $1.64 for every dollar they make.” An all-time high.

– Avg. price of a detached single family home in Canada is currently $454,342 CAD as of Dec. 31, 2015 (up 12% year over year) according to the Canadian Real Estate Association (CREA). Another all-time high.

– In comparison, the median family income is approx. $76.5K CAD according to Statistics Canada, meaning the avg. home costs about 6x a family’s annual income and more than 16x the median individual income of $27.6K. Both all-time highs.

– Avg. price of a detached single family home in the US is $236,400 USD as of Dec. 2015. Up 6.5% year over year. Historically Canadian home values have lagged US values when looking back over past quarter century of data. Today Canadian home values are just about 34% higher than their US counterparts, taking currency conversion fully into account.

– Canadian property price-income ratio is currently 35% above its 50 year avg. as of June 2015 and at an all-time high. Meaning if we assume an avg. residential property rental price of some $1,700 CAD per month or $20,400 CAD per year (which is aggressive) that only yields approx. 4.5% given the avg. home price currently in Canada. This is of course not accounting for borrowing costs (avg. prime rate for fixed 5 yr. mortgage as of Jan. 2016 is 2.57% ), taxes, any other property maintenance costs and so on.

By this same measure the Vancouver B.C. (thought by some including this author to be one of the most over-priced in the world) price-income ratio is over 37.0 at present (yet another all-time high for those keeping track at home). As an additional consoling fact, anything above 15-20 is traditionally considered high;)

– Household starts (number of new homes built) were a seasonally adjusted 230,071 in fiscal year 2015, while new household formation (demand for new homes) was under 190,000 according to the Canadian Mortgage & Housing Corp. (CMHC). According to most available data, starts have outstripped formation in each of the past 6 years (with only a slightly dip for new starts experienced in the troughs of 2008 before resuming their upward march).

– Sub-prime residential loans make up approx. 4.5% of the total mortgage market and growing (up close to 50% in past 24 months from 2013-2015 alone).

– To wade into some murkier, less clear waters, the number of residential mortgages in arrears (or foreclosures) is less obvious as the CMHC (the previously mentioned Canadian federal government owned mortgage insurer which backs over 50% of all new mortgages originated per annum) is mum when it comes to foreclosure statistics.

But if we scour deeper we can find that according to the Canadian Bankers Association (CBA) the national foreclosure rate is only some 0.27% as of September 30, 2015. Bottom bouncing near an all-time low.

When it comes to the ever-elusive foreign ownership of property figure, statistics are non-existent in Canada at present. However, a recent in-depth Globe & Mail investigation looked at publicly available data (land titles, court records, tax reporting) and estimated that out of 250 detached single family homes purchased for over $2 Mil. CAD in the past two years (2014-2015) in metro Vancouver, B.C. Over 85% had “foreign names” listed as their primary owners of record.

I am careful not to deduct much from such a small, local sample size, but should the real foreign ownership percentage across Canada be anywhere near even 5% of the total market or more (which again is officially unknown), this could cause further disruptions should Asian and other global economies deteriorate or face recessions of their own.

 

Bonus Stats:

  • While Canada ranks a mere 32nd globally in terms of its home ownership rate, this statistic is also presently perched atop an all-time high of 67.6%. Some provinces such as Calgary, Alberta have even exceeded this with approx. 72.4% of its residents owning their own home until only recently beginning to fall in the second half of 2015.

 

  • The Canadian housing sector (defined as residential real estate development, home construction and brokerage services) now make up approx. 20% of Canada’s Gross Domestic Product (GDP), the highest proportion since 1989. Before the well, real estate downturn of the early 90’s.

 

  • The average home price in Canada is up 63% since 2000 compared to a 13% increase in median after-tax income of average households, as per The Federation of Canadian Municipalities Crunching Canada’s Housing Numbers.

 

From all of the above, an obvious inference can be drawn regarding the risk/reward ratio (hint: it is long on the former, much shorter on the latter) of being positively exposed to the Canadian property sector. The Federal Reserve of San Francisco’s (whom i cannot believe i am quoting here:/ definition of a “bubble” is:

“Economists use the term “bubble” to describe an asset price that has risen above the level justified by economic fundamentals, as measured by the discounted stream of expected future cash flows that will accrue to the owner of the asset. The dramatic rise in U.S. stock prices during the late 1990’s, followed similarly by U.S. house prices during the early 2000’s, are episodes that have both been described as “bubbles.”

By this very definition – based on “economic fundamentals” as just illustrated, Canada’s residential property market is in a dare i say it…bubble!

 

Update: After hearing hearing from many (positive reinforcements, thoughts and criticisms alike) in response to the above, i am going to be posting my replies to many questions below on an ongoing basis:

While there is always the possibility that i could just be plain wrong. That this really is a “new normal” and that the currently prevailing economics remain intact for the next decade.

I have of course considered this, but it would be empirically unprecedented in recorded history. In looking at the US, Australia, Spain, etc. whenever the underlying fundamentals of their domestic housing markets reached anywhere near where Canada’s is at the present – large corrections followed.

The two predominant counter arguments i have heard for this “new normal” are:

1) Metro Vancouver B.C. specifically has a limited land mass therefore demand will always exceed supply.

This is of course topographically accurate, but Metro Vancouver vacancy rates have been around 1-2% for over 30 years now, yet property values have never been as high as they presently are. Why?

The topography argument fails to heed the pernicious effect the 2008 economic stimulus plan and artificially low interest rates have had in distorting the market for the past 8 plus years. Without this unprecedented flow of credit, asset values (including real property) would not be anywhere near as inflated as they are today.

2) Foreign investors will always choose Canada as a destination for their capital.

This is an interesting argument and one that i don’t believe most commentators have a full grasp of as it requires some “second level thinking” as Howard Marks likes to say.

In order for this argument to prevail economic conditions in the developed world would have to indefinitely remain as they are today – artificially low interest rates, accommodating monetary policy, business/asset values remain at or near their highs today.

While foreign property ownership data does not officially exist, we can debunk this fact simply by looking at what is no doubt one of the largest foreign property owners in Canada – China (as they are in the US). We can already see that business/asset values are already beginning to trend lower across Asia. Why?

To an even greater extent (a much greater extent:/ than Canada, China has manifested the largest credit bubble in human history ($20 Trillion+) through much the same measures – unprecedented economic stimulus, quantitative easing, artificially low interest rates and other market intervention. This credit went into and inflated asset prices including property (sound familiar;) only on a much, much grander scale than anywhere else in the world.

While Chinese markets have capitulated to an extent once again due to unprecedented direct intervention by the People’s Bank of China (PBOC). I don’t believe i have to remind anyone here that such measures are simply not sustainable over the long-term and as more and more market participants come to this same realization, public assets will be liquidated and as a direct result their values will be slashed along with both personal and corporate net-worth’s leading to less capital flowing directly into Canada than in the recent past.

“The market can remain irrational longer than one can remain solvent” as i like to always remind myself, but this has already occurred by and large over the past decade. I wouldn’t mind being wrong in this particular case as that would mean that a lot of pain will be avoided by a great many people, but i haven’t seen any tangible data as yet that would point to this being the case or that has any past precedent in this respect.

 

Investor alert: The author or the author’s company as well as affiliated entities and accounts own securities and private businesses that are inversely correlated to the Canadian housing market, and financial industry.

 

 

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