A Canadian Housing Bubble?

by: Saj Karsan

When the U.S. underwent its housing bubble (and subsequent burst) a few years ago, there were a few signs of trouble. New home inventories were high, as expectations were through the roof (never a good sign). Homebuilders traded several times their book values, suggesting extreme optimism and over-building (to capitalize on unsustainably high profit margins). Price to rent and price to income ratios skyrocketed.

Today, many are saying similar residential real estate bubbles are occurring in China, Australia and Canada, to name a few. As a homeowner in Canada, I'm interested in studying this phenomenon so as to ensure I don't end up on the wrong side of it, much like many of my unfortunate American brethren.

Clearly, Canadian house prices to incomes have fallen out of line with their historic norms, as have Canadian price to rent ratios.

But another thing we have learned from the U.S. housing bust is that not all regions froth to an equal degree. Las Vegas and Phoenix, for example, saw massive declines when the bubble finally burst, while other places escaped with barely a scratch. Canada is a particularly geographically diverse (in terms of natural resource availability, types of industry etc.) nation, and so it's conceivable that the stress of any Canadian housing bust will be felt to varying degrees, depending on the region.

To that end, I've compiled several years worth of new home inventory levels for three large Canadian cities and their surrounding suburbs (source: CMHC): Vancouver (which is the most expensive city), Toronto (the largest city), and Calgary (which is somewhat reliant on the oil market for its level of prosperity): (Click to enlarge)

From this chart, it hardly looks as if inventories are out of control, as they are well within their range of the last decade. In fact, there may even appear to be a shortage of homes in Toronto.

However, switching to the condo market, one does start to see some potential over-optimism on the part of builders, resulting in very high inventories of as-yet unsold new multi-family units: (Click to enlarge)

Here we see how hot Vancouver is compared to the other cities. But wait! The above chart isn't adjusted for population. Toronto's population is more than double that of Vancouver's, and yet Toronto has only half as many condos available. Adjusting the inventory chart for population makes the situation look like this: (Click to enlarge)

Clearly, there are a lot of new condos in Vancouver, both on a historical standard and compared with other cities. For now, there are enough sales taking place in Vancouver such that this inventory is not staying on the market long enough to significantly pressure prices. But that can change in a hurry. A rise in interest rates or a reduction in consumer confidence or some other shock could reduce demand, and that would leave a whole lot of properties on the market. Whether this situation will also affect the detached home market is anybody's guess, but if capital becomes tight as a result of fear in a certain part of the housing sector, it may take the whole sector down with it... who knows!