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The Canadian Market: When Will The Housing Bubble Burst in Canada?

Canada’s home prices had been surging from 2001 to 2008 and later dropped during the global financial crisis. After the crisis, these prices have continued to increase as the U.S prices remain strictly controlled.

This has caused a stir with some economists predicting that the surging prices are a sign of a real estate bubble, which may burst any time. The U.S housing market was in a bubble in the early 2000s. It later plunged leaving American home owners with a higher mortgage than the house value. 

There are some similarities in the housing bubble between Canada and the U.S. But economists say that Canada is likely to experience a soft landing. This may be attributed to measures put in place by the government to avoid the U.S style real estate meltdown.
Graph1 

According to the Bank of Montreal, the gap between the average price of a home in Canada and the United States has widened within the first quarter of 2014. This was the exact opposite of what economists had expected. Up until March, Canadian home prices were 66% above the average U.S home prices. 

These are the average home prices for existing houses and condos. Note that these prices are not inclusive of newly constructed houses.

The construction industry is unique because other sectors such as finance, real estate and insurance depend on it at different levels. The construction industry holds 7.5% of the Canadian workforce. While residential construction contributes 7% to the economy. Since 2000, the construction industry has contributed 45% of Canada’s gross domestic product growth.

This worries economists because a decline in this industry could have profound effects on the economy.

Canada’s unemployment rate has significantly increased from 6.9% to 7.2%. If unemployment levels continues to rise as a result of increased interest rates and or a decrease in construction spending, the enormous debt load may be a threat to the economy.

This debt has partly inflamed the housing bubble. Over the last two decades, the ratio of the Canadian household debt to disposable income has risen from 80% in 1990 to slightly above 160% in 2014. Canada’s housing debt exceeded that of the U.S, which was recorded at 130% proving that Canada’s housing bubble is bigger.

In a report released by Teranet- National Bank, Canada’s home prices have soared. The housing index rose from 60 in March 1990 to 160 in March 2014. According to the Bank of Canada, most Canadians are susceptible to high interest rates because the share of consumer loans absorbed by home equity lines has risen sharply.
Graph2 

If the interest rate is increased, the bubble may burst. Economists say this is unlikely because in April 2014, the Bank announced that it was keeping its lending rate at 1%. The bank anticipates that exports and investments will exceed consumer spending to enable growth of the economy. The bank made it clear that it would not raise rates soon.

Economists suggest that house prices may drop in the next two or more years. You cannot compare the American and Canadian markets because the U.S pre-crash environment is very different from that of Canada.

While Canada’s debt to income ratio has exceeded that of the U.S, it shouldn’t cause much alarm. There are countries, which have had larger debts and have not crashed. The government has set new rules- cooling measures- to control the entry of new buyers in the housing market. Home buyers are not allowed to borrow 100% and the amortization period has been reduced from 35 to 25 years. New buyers will also be required to make larger down payments and mortgage refinancing is more difficult.

The U.S financial meltdown was caused by the seizure of housing finance. Major investment firms such as Merrill Lynch, Bear Sterns started to collapse.

People lost confidence in mortgage backed securities and no one thought that house prices could actually fall. House finance works differently in Canada as 75% of 1.2 trillion mortgages are government guaranteed. The lenders are guaranteed by the government and mortgages are endorsed by the government’s triple A credit rating. Therefore, Canadian banks can hold these mortgages with zero risk. Housing finance will continue to run as long as the government guarantees the loans. What counts is the availability of credit as opposed to the cost.

To sum it all, Canada is unlikely to experience a financial melt-down similar to that of the U.S because of the presence of government insurance. However, this doesn’t mean that Canada will avoid the consequences associated to a bubble burst.

Home prices are highest in Vancouver and Toronto though new data shows that the markets have started cooling. This is a clear indication that the housing market is headed for a soft landing. According to the Canadian Real Estate Association, the ratio of sales to new listings has dropped.

However, some economists have said that it’s only after the bubble burst that Canada will know if they’ve had a soft or a hard landing. Canadians should avoid incurring more debt and start paying off what they owe.