We are heading towards the end of 2009 and the Canadian real estate market is on fire. Record numbers of sold homes, record prices, bidding wars… All this is happening while we are coming out of the worst recession in 90 years, Canadians are losing their jobs, and the stock market is down 40% from its’ high. Here are 5 factors that might burst the housing bubble:
Image by woodleywonderworks
1) Demand Could Weaken
One reason that the housing market is booming right now in Canada is because we are caught in a mini “demand bubble”. This demand is coming from A) the lack of sales last winter where buyers put off the buying decision during the financial crisis and B) buyers looking to buy before rates increase. All the home owners that didn’t buy from Sept ‘08 to March ‘09 are competing with the buyers who want to take advantage of the low mortgage rates. This demand is most likely “stealing” home sales that should be reserved for 2010. This means that the demand could weaken in the coming months because everyone has already bought!
2) Mortgage Rates Will Increase
The Bank Of Canada said that rates will remain low until June 2010….but then they will go up. It’s impossible to know how quickly rates will increase, however, simple math dictates that when mortgage rates go up, homes become more expensive. This will create weakness in home sales and it might drive down prices. The mortgage rate over the last 20 years has averaged around 8%, and for the past 5 years, most Canadians have been obtaining mortgages at 4-6%. If buyers are getting caught up in a bidding war and overpaying for a home that they can barely afford, at 4% interest, then they might have difficulty paying a 7-8% mortgage when rates increase.
3) No More Room To Move
In the past, whenever there was weakness in the housing market, the Canadian Government loosened the mortgage restrictions in order to stimulate the housing market. The government extended the amortization, reduced the amount of the minimum down payment, and increased the RRSP amount that can be used by 1st time buyers. There is now no more room to move (assuming that we won’t go back to allowing $0 down and 40 year amortization which was allowed in 2008). More than 50% of all mortgages in Canada this year were amortized longer than the standard 25 years. This means there is very little that the government can do to simulate the housing market if sales weaken. If the housing bubble bursts, and housing prices crash, then that means we are on our own.
4) Unemployment Rate
Some economists predict that the unemployment rate in Canada will hit 10% in 2010. It is currently at 8.6%. When people lose their jobs, it becomes hard to pay their mortgage. Some people might take out a line of credit to help them until they find their next job, but others will need to sell their home. A poor job market will create more supply and, at the same time, it will create less demand because fewer jobs means that less people can buy.
5) Home Prices Decrease
If higher mortgage rates, higher unemployment rate, and a weaker demand make housing prices start to decrease, then watch out. Decreasing home prices are a very slippery slope. Deflation has been identified as the pro-longer of the great depression. When the price of a product is decreasing, and consumers know that they can buy the product in a few months at a cheaper price, then they will wait to buy. This “waiting” is poison for any industry. The more consumers wait to purchase, the faster prices fall. The more prices fall, the longer consumers wait. It’s a vicious spiral! We saw a brief glimpse of this from Oct 08 to April 09 as Toronto home prices started to crash when no one was buying.
No one can predict if the bubble will burst. It might not even burst. Perhaps homes in Canada were already priced low (compared to New York, Hong Kong, Dublin), perhaps the economy will continue to improve, interest rates will remain low, and salaries will increase. Regardless of what happens, it makes good personal financial sense to examine multiple “what if” scenarios before you pay $50,000 over asking with 5% down and 35 year mortgage at 4%.
This is a guest post by William from ByTheOwner.com, a blog about real estate, saving money, and selling a home without an agent. If you liked this post, please consider subscribing to his RSS feed.
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Wow, didn’t realize Canadian real estate is on fire! Things are picking up here in San Francisco and Lake Tahoe, but I wouldn’t say things are on fire. Very interesting.
I know Asian property prices are at all time highs now, especially China.
I’m trying to buy some rental property right now myself!
Best,
FS
Financial Samurai´s last blog ..The Katana: Favorite Posts of The Week Ending 11/15
BTW, can you elaborate on why the Canadian prop market is on fire again, and how much prices fell from the peak, whenever it was?
Love to get more perspective as I don’t think any cycle is really unique in the world. Your story makes me more bullish on the US property market.
Financial Samurai´s last blog ..The Katana: Favorite Posts of The Week Ending 11/15
FS,
Canada had a drop last fall as worldwide panic set in. But we didn’t have the same underlying mortgage crisis and now with the record low interest rates it’s picked up again. Basically we only had a slight dip and the bubble has started to build again.
The Globe and Mail wrote a similar story today, Canada’s housing rebound sparks fear of bubble.
Hopefully as the unemployment rate improves that will create additional demand to help soften the bubble.
It’s scary when you see families have to pump in so much of their net worth into a home; particularly if they live in areas such as Vancouver or large centres where homes are easily >$500,000.
I get the impression that Canadians are at risk of the possibility of a housing bubble in the short to mid-term but for one reason or another, I feel as though our financial system is robust enough in a sense that we would not witness the same type of situation exhibited south of the border.
Regardless, it was an interesting thread!
Good stuff
The Rat´s last blog ..Do You Have Any Gold In Your Portfolio? Part II
Interesting Tom. Perhaps the Canadian housing market really isn’t in a bubble?
What’s the average price / square feet in the most prime of areas in your neighborhood?
Financial Samurai´s last blog ..The Katana: Favorite Posts of The Week Ending 11/15
I hope deflation takes hold. I hope prices drop! I haven’t bought a house and will want to someday. However, these govt. policies and misguided belief that we ‘need’ about 2% inflation is a joke. It hurts 20-somethings like me and only helps the older generations. Who wouldn’t want to buy many things at a lower price? People were building and buying rather large homes in the 80s around $100,000. At 3% inflation compounded annually, that is roughly $180,000-$200,000 today. However, these homes are selling for $400,000+ now. Why do Canadians have this ingrained belief that home prices only rise? As if they’ll go up forever.
I think the big metric to consider is to compare home price to median income. This data is rather hard to locate, but if you can find it for your market, it should tell you:
1) if there is a bubble
2) present location in the bubble (upside or downside)
The NY Times plotted this for a few major American cities, and man, it was powerful stuff.
http://www.nytimes.com/2009/04/22/business/economy/22leonhardt.html?_r=2
Not surprisingly, San Francisco, New York and LA lead US in the bubble driven markets.
Matt SF´s last blog ..New Frugality Appears to be More than Just a Fad
With countries getting out of a recession and making money again they should take it easy and not go rushing into giving bad debt again and should give good rate that they can offer and go from there. There is an increase in unemployment but it should start to go down now with more economic stability and possible industrial up rise. One major thing with buying a home is don’t over stretch your financial ability, especially with changing interest rates.
housing finance advice´s last blog ..30 Year vs. 15 Year Mortgages