Unlike the United States where property values have plummeted since the economic crisis which started in 2006, the Canadian housing market has been and remains hot. As prices continue to rise, and supply continues to grow, the question on everyone's mind is when will housing prices start to come down. The answer could be sooner than we would like.
The problem is twofold. Issue number one, is the large supply of housing and new construction, while issue number two is the high debt level of Canadians.
A truly troubling statistic that Canadians do not like to talk about is debt. Canadians are heavily in debt. In the early 1980's if the average Canadian had $100 he/she owed $66 of that money in debt. In the fourth quarter 2012, that same Canadian who had $100 would be -$50 in debt on that same $100. "In 1980, the ratio of household debt to personal disposable income was 66%; that ratio recently passed the 150% figure (Statistics Canada 2011)." Not only is the average Canadian in debt to a level greater than their annual (net) income after taxes but it is approaching a level that is questionably unsustainable.
Statistics Canada defines disposable income as "Pre-tax income less federal and provincial income tax less premiums/contributions paid on components pertaining to security." So the average Canadian goes to work pays their taxes and the money that they have left over would need to appreciate by 50% in order to satisfy their debts. One might think that this relationship of debt as a percentage of disposable income is unsustainable, however housing prices are questionably high enough to cover, as long as those asset prices remain high enough.
In the third quarter 2011, the percentage of debt to assets according to Statistics Canada was 20.37% so if need be there would be sufficient assets to cover any debts if necessary. In Canada, most people's largest asset is their home, and according to Statistics Canada real estate as a percentage of personal disposable income in the third quarter 2011 was 300%. The value of real-estate could cover ones debt three times over on average.
With high levels of debt that are 150% more than what the average Canadian makes after taxes, having equity ownership of a home means that as long as the value of the home stays high enough, it could be sold to cover the debts. Interest rates have been at record lows over the last 4-5 years. The low return on interest bearing investments compared to mortgage debt (which is normally renewed on a five year term,) means that the level of debt is only going to get higher as the interest payments are low, and debt payments are high. What is worse is that when rates eventually increase mortgage rates will rise and reduce demand in the housing market. Either to combat inflation or due to high commodity prices, the dollar, or other central bank actions, the Bank of Canada will eventually raise interest rates.
With the housing market on the verge of oversupply and with higher rates eliminating new home buyers, the excess supply and low demand for homes will cause housing prices to fall. When this happens the ratio of debt to disposable income may not change much, but the safety net of our assets covering our debts, may no longer apply to the extent it does at present.
Lower home prices will cause people to sell in order to raise necessary cash while higher mortgage rates will choke out demand. This problem is the single greatest threat to the Canadian economy. The level of debt for the average Canadian especially those strapped for cash is too high to support rising interest payments on a depreciating asset. If there were low levels of debt then falling housing prices would be absorbed by the ability to go into debt to cover increasing costs of a mortgage. What is going to happen is that the costs of a mortgage are going to go up, while the value of the real-estate is going to go down.
As housing prices start to decline, there will not be a rush of new home buyers to save the market. In a domino effect, lower housing prices will only lead to even lower prices.
We are an indebted nation who is relying on high commodity prices to carry us forward. If rates increase, or the supply of housing continues to increase it is only a matter of time before a collapse in housing prices lead us into a recession.
Appendix: Statistics Canada:
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