One of the newsletter writers that I subscribe to insists his recent bearish attitude towards Canadian housing has cost him almost all of his Canadian subscribers. He claims that Canadians don’t like hearing that we are repeating the same mistake that the Americans made during the mid 2000s.
I like to think that we are a more resilient bunch. I don’t have the heart to tell him that if anything, we get more offended by his political views than we do about the fact that he thinks our housing market is going to fall.
After all, he is writing his newsletter for Canadians involved in the finance industry. We are well aware that housing prices can go down.
In fact, although today the average Canadian house price is hitting new highs, the market is much more bifurcated than most pundits understand.
During the mid 2000s, when China was snapping up every commodity under the sun, the Canadian real estate market rose from being dragged up. There were an elite group of Canadian society associated with the financial markets and the commodity companies that bid up the price of higher end houses. This section of the real estate market exploded higher. Housing at the lower end benefited somewhat, but not nearly as much as the higher end. When the 2008 crisis hit, this rise ended. Since then the supposed froth has completely failed to return to this upper end section of the real estate market. I would argue that many of the homes/cottages in this price bracket have still not hit the highs seen before the credit crisis.
Have a look at his chart of the Muskoka Average Sale Price from the Royal LePage AbenTeam blog. For those who don’t know – Muskoka is like the Hamptons of Toronto. Charting the price of high end cottages is the perfect indicator for what is going on with real estate for the Canadian 1%.
You will notice that the three high end lakes (Joe, Muskoka and Rossea) have all failed to surpass their 2007 highs.
Contrast that to the average house selling price across Canada:
Teranet National Bank Canada wide real estate index</a> </div></p>
The 2008 decline was quickly met with a renewed bounce. Within a year the national house price had pushed to new highs.
This was because the next round of Canadian house appreciation was pushed from the bottom up, as opposed to being dragged up from the top as during the 2000–2008 bull market.
Since 2008, the Canadian real estate market rise is being driven through an appreciation of lower priced homes. These new buyers are myopically focusing on the monthly payments – completely ignoring the risks. The record low interest rates are attracting new buyers to take on more debt than they would otherwise be able to afford. In Canada we cannot write off our mortgage like our American friends, so our higher end homes are generally not as sensitive to interest rates.
The upper end homes of the clients of my newsletter writer have not been participating in this real estate mania. They are well aware that the Canadian real estate market can go down because in a lot of cases even though the headlines scream otherwise, their houses have been slowly eroding for the last 5 years.
I am lucky enough to live in an affluent neighbourhood in Toronto. Although my house is definitely not in the same league, being a student of the market, I enjoy watching the prices of the really high end homes. I have noticed that they are still no where near the levels of 2007.
The supposed Canadian real estate mania that many Americans analysts are worried about is not nearly as across the board as they believe.
There is no doubt that the lower and middle portion of the real estate market is getting frothy. These buyers are mistakenly placing too much emphasis on the cost of the mortgage as opposed to the price of the home. This is resulting in too much debt being drawn down.
However the government is working on trying to cool this portion of the market. They have tightened credit standards in a couple of different ways – trying to fine tune a gradual slowing down.
But the Americans continue to think that our housing market is a replica of their boom bust cycle. I have said it before, and I will say it again – the Americans are going to be frustrated by our “Canadian-ness.” We are more boring and less prone from running from one side of the boat to the other.
When ZeroHedge writes articles with headlines like “The Canadian Housing Bubble Puts Even the US to Shame”, I know that the market is expecting a dramatic move.
My newsletter writer has even called the shorting of the Canadian market a “career making trade.” To take advantage of this common belief, there are a myriad of hedge funds solely set up to bet against the Canadian real estate market.
During the 2000s when the US real estate mania was in full bloom, there were online real estate calculators to help figure out the cost of owning a home. In these calculators, there was never an option for housing price depreciation. This attitude was even prevalent throughout Wall Street as the models used to price mortgage bonds did not have an option for negative price movement because real estate prices had never gone down on a nationwide basis.
Contrast that to the current articles in the Canadian papers. In this week-end Globe and Mail there was an article titled Housing price calculator: How would a correction affect your selling price? The sole purpose of this article was to highlight what would happen in a real estate correction. It also highlighted how price declined by almost 25% during the 1989–93 slump.
Will Canada suffer a decline in house prices? Yes of course. We are indeed layering on too much debt at all time lows in interest rates. Many of these buyers will not be able to handle rising rates.
But will Canada’s real estate market experience a bust in the magnitude that the Americans experienced in 2007? I would argue that the odds do not favour that outcome.
There are many reasons that I feel this way, but the most compelling one is the simple fact that everyone is expecting the same sort of market crash. When everyone is expecting something, very rarely does that happen.
The Canadian real estate market is not filled with universal speculation across the board. The higher end stuff has in fact probably gone down over the last 5 years. At price points below that, there is indeed too much buying with only worries about next year’s mortgage payment in buyers’ minds. But the government is clamping down on that portion of the market and trying to gradually tone down the excitement. This is in contrast to the American situation where the authorities did nothing (and in fact encouraged it) as the speculation intensified.
My guess is that the short Canadian real estate market trade is not going to be a “career making trade” for my newsletter friend. I don’t think that I have ever seen someone correctly predict which trades are “career makers.” And in fact, I have seen all too many traders anger the Market Gods with this sort of lack of hubris. The Market Gods seem to love to remind us about the difficulty of this great game. I won’t tempt them by claiming that I know anything for certain, but I would humbly suggest that when everyone is expecting a “career making” Canadian real estate crash, you would be better off trying to find easier trades. As for my newsletter writer, I almost feel like his claims about Canadians abandoning him because of his negative views is just a marketing ploy. Hs is trying to encourage his Canadian clients to stay subscribed just to show him he is wrong about us…
You see, as long as you don’t insult our hockey, you can pretty much make fun of anything Canadian. We even love to do it to ourselves. Have a look at this tweet from Paul Kedrosky (who is a Canadian- turned American tech writer):
An Englishman, a Canadian and an American are captured by terrorists. The terrorist leaded said, “Before we shoot you, you will be allowed last words. Please let me know what you wish to talk about.” The Englishman replied, “I wish to speak of loyalty and service to the crown.” The Canadian replied, “Since you are involved in a question of national purpose, national identity, and secession, I wish to talk about the history of constitutional process in Canada, special status, distinct society and uniqueness within diversity.” The American replied, “Just shoot me before the Canadian starts talking…”
Canadian middle class
Since I have already probably upset some of my American audience by suggesting that their predictions of the coming Apocalypse in Canadian real estate might not be as dramatic as they predict, I might as well continue on and talk about the other recent economic headline that is gathering attention.
Recently it was reported that for the first time ever, the typical middle class Canadian is now wealthier than the equivalent American. This will no doubt be explained away by my bearish American friends as the direct result of a Canadian real estate bubble that has yet to bust.
I have no quibbles agreeing that the fact that this news is hitting the main stream media outlets means that the trend is probably coming to an end.
For as long as I can remember, Americans have been wealthier and it is now a little uncomfortable finding that gap drawn to zero. Like the aging hall of fame hockey star that now finds the young upper comer in the hunt for the scoring trophy, I have no doubt that the American economy is about to put on the jets and put some pucks in the net.
However, I want to point out one aspect of this economic race that puts Canada at an unfair advantage.
Have a look at this chart of where the American tax dollars go:
More than a quarter goes to the military! I am not going to get into a political discussion of whether this is good or bad, but I merely want to note that the Canadian economy does not have this economic drag. Given this massive unproductive spending that weighs down the US economy, it is actually quite pathetic that the Canadian economy is not wealthier than the American one. It is a testament to the strength of the American economy that they can spend this sort of money on the military and still have the world’s largest economy.