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The other day a Toronto crane operator was greeted by an unusual visitor. Although the construction worker was over 700 feet up in the sky, that didn’t stop a determined raccoon from climbing up to pay the operator a visit. Most people think the raccoon was searching for food, but we know the real reason he made the trek. The raccoon, like most other market watchers, was fascinated by the continuing real estate boom that Toronto is experiencing. He wanted to get a first hand look at the growing myriad of towers that are littering the Toronto skyline.

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The racoon had a quick look at the sea of glittering glass buildings and realized that the US hedge fund guys were probably right – Toronto is a real estate bubble desperately looking for a pin. The raccoon scrambled back down the crane ladder, hoping that he could get down in time before the CME closed and he could short some more Canadian dollar futures.

Now I don’t claim to know what is going on with Canadian real estate, but I do understand all the bearish arguments.

For example, I know about the alarming growth in Canadian debt:

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And I am aware of the much repeated fact about how Vancouver is the second least affordable housing market in the world.

Don’t think for a second that I don’t realize the chart of prices has been headed unsustainably higher for the past 6 years:

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Since the dip during the 2008/9 credit crisis, Toronto prices have climbed over 60%. That sort of pace will not last.

Yet I am perplexed at the continuing strength in the Canadian real estate market. Like the raccoon, I am puzzled by all the new buildings that are going up.

At the dog park near our house, there are a couple of real estate agents I chat with while our dogs play. The other day I asked about the recent Bank of Canada surprise rate decrease and whether that has driven more buyers into the market. Although I understand that the upper end is less sensitive to rates, I expected their condo buyers and other lower bracket buyers to be quite responsive to a lowering of their cost of credit. After all, if this is a debt driven bubble, the cost of that debt should be the most important determinant in the price of housing.

This is far from scientific, but these two agents were of the opinion that although rate decreases help at the margin, the buyers for many of Toronto’s new properties are not nearly as sensitive to rates as the common wisdom would have us believe.

Their belief is that Toronto’s housing boom is being driven by immigration. They are overwhelmed with overseas buyers who look at Toronto as a large, safe, livable city, with a stable government, and although the weather stinks in the winter – great value. These immigrants are used to living in dense metropolitan areas, and Toronto real estate seems downright spacious to them. One of the agents even cited the fact many of these immigrants would have previously gone to the United States, but the events of the past decade have swayed them into choosing the more benign Canada.

I know that there is no way real estate agents are going to be anything but bullish at the top. I don’t expect them to call the point of maximum exuberance. Yet I am willing to keep an open mind about what is driving this boom.

If we accept that immigration is one of the driving factors behind this Canadian real estate bubble, then we need to look at the Canadian housing price index for these foreigners in their native currency. Although they are paying Canadian dollars for their property, they are converting their local currency to buy those Canadian dollars. Therefore the relative price action of the Loonie is hugely important. I remember the 1990s when the USDCAD rate went from 1.15 to 1.60 that the summer recreational area of Muskoka (the Canadian equivalent of the Hamptons) became swamped with Americans buying up monster places. For them, the cheap Loonie made Muskoka a fabulous bargain. Even with the extra cost of travelling from NYC, for $5 million CAD (which was only ~3.3MM USD) they could buy a place that would be $20MM in the Hamptons. For a while it felt like every time I turned around there was another American buying a big cottage. When the 2008 credit crisis hit, the USDCAD rate was trading at 0.90 and many of these Americans sold their Muskoka places that had appreciated in nominal Canadian dollars and when combined with the huge sell off in the value of the US dollar, made their trade a huge win. Even though since the credit crisis Canadian real estate has exploded higher, Muskoka real estate has lagged because at the margin there hasn’t been any more of this big American bid. The lesson I learned is that the value of a country’s currency can affect the currency more than many pundits realize. Therefore when we talk about Toronto real estate we need to keep in mind that many of these immigrants are coming from China and their currency has been rising versus the Canadian dollar.

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Therefore although the price in nominal Canadian dollars for Toronto real estate has rallied 46% since the start of 2008, in Chinese Renminbi, the price is up only 3.4%.

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For a rich Chinese person who is thinking about emigrating to Canada, or more likely sending his kids over here to live, the price of Toronto real estate has gone sideways for the past 5 years.

I have no idea how long this can continue. One of my co-workers lives in a tower in a younger part of the city and he tells me that it is filled with Asian kids driving much too nice cars for their stage in life. It seems like whenever I see a fancy new BMW i8 or some other exotic sports car on the road in Toronto there is a kid who doesn’t look old enough to shave driving it.

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There is no doubt that my dog park real estate agents have to be at least partially correct that this influx of immigration is driving the Canadian housing market. I don’t have any clue when this is going to end. I actually would have thought it would have already be over, but it shows no signs of even slowing down.


The market is leaning bearish on everything Canadian

I do know one thing though. A lot of any decline is already built into the price of many of the macro prices for Canadian assets. Hedge funds have been shooting at the Canadian market for the past couple of years. American hedge funds in particular look at the Canadian housing market and can’t imagine it ending any other way except with the same implosion that they experienced. I have said it once, and I will repeat it again – we are going to bore them with our Canadian-ness. Will Canadian real estate eventually correct? For sure. I suspect that we will have years of underperformance to correct the massively overpriced nature of our real estate. But it will not end in some 2008/9 massive implosion like the American real estate market experienced.

First of all, everyone always imagines the previous crisis as the next one. But how often does that actually play out? Almost never. After the 1987 equity crash, there was constant calls that the stock market would experience another 20% one day down draft. Yet it never occurred. This phenomenon happens over and over again. All that market participants can do is extrapolate recent past events into the future. By doing so, they almost ensure that the recent mistakes are not repeated until they are forgotten. The simple fact that the US real estate crash is so fresh in everyone’s minds makes the probability of it happening with the same ferocity in Canada low.

Secondly, we are by nature a boring people. It just isn’t in our personality to run from one side of the boat to the other as quickly as our American neighbours. I am not judging this fact as a good or bad quality, it just is what it is. Therefore I don’t think the inevitable Canadian real estate correction is going to happen nearly fast enough for our US hedge fund friends.

And finally, I think that market participants have underestimated the potential for global growth in the coming quarters. Everyone is exceptionally bearish on global economic prospects, but that is slowly changing at the margin. Smart guys like Stanley Druckenmiller are positioning themselves for the surprises to be to the upside. Canada was a favourite short for these global economic bears, with the added potential benefit of a much anticipated real estate bubble bursting. Yet if the global economy is bottoming, then Canada will surprise on the upside in a global upturn. Very few are positioned for Canada to do anything but continue its relative poor performance. Although some might accuse me of being overly bullish on Canada due to my home bias, I am actually more hopeful on China’s prospects than anything else. I just think that as goes China, so goes Canada.

I don’t understand the wave of money that is flooding into our country’s real estate, but I am not nearly smart enough to be able to time the top as perfectly as my American hedge fund friends that are convinced the end is near. And in fact, I think the Loonie deserves a shot on the long side as it is already showing signs that things are not quite as bad as the hedgies believe… I will take the other side of the raccoon’s short CAD bet…

Thanks for reading,

Kevin Muir

the Macro Tourist

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