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Shorting Canadian Real Estate?


There is a current change in trends in Canadian Real Estate.

Canadian debt is reaching unsustainable levels.

Canada's largest banks are heavily invested in mortgages.

I don't write too often on Seeking Alpha, but this is a topic that has been on my mind for a while now, and I'm starting to read more and more headlines about Canada's real estate.

I live in Vancouver and I probably don't need to tell you that the housing market is insane to say the least up here. You can play a game online called Crack Shack or Mansion and you need to guess whether the property displayed is a multi million dollar Vancouver "Mansion" or a literal crack shack; that's how bad it is getting. Rent prices for a 300sq foot studio downtown are around 2-3 grand a month; these are not fun prices for the average Canadian household, or even worse if you're a young adult or student. You could argue that it's basic supply and demand, and I would agree with you, but demand is slowing down in Canada and prices for general goods are still increasing; we are flirting with stagflation.

I will go into a little bit more depth on what the deal is up here, and I will float the idea of shorting the Canadian housing market.

So what's the deal?

This article won't be too long, but I will share the various statistics about Canada's current real estate market and why there is reason for skepticism.

I'm also not going to recommend investors to take out credit default swaps against the mortgage market a la Big Short, but perhaps investing in shorting some real estate heavy stocks or finding bear ETFS on Canadian housing.

Firstly, the first statistic I want to throw at your faces is the UBS Global Real Estate Bubble Index 2016. UBS AG has warned that Vancouver is the number one city when it comes to a real estate bubble and Vancouver was prominently ahead of other notorious bubble cities like San Francisco, London, Toronto, etc. The report outlines the probability of a market crash based on certain economic conditions that are not looking too great for Canada right now.

The average home in Canada costs around $500,000 and that goes along with the national average income of around $40,000. Now consider this: the average home in Vancouver costs around $1,000,000 and the average income is just barely above $40,000 in Vancouver.

Add on to that the fact that Canada has one of the worst debt to income ratios out of developed countries in the world, and you got yourself a cause for trouble. The average Canadian is spending 165% of their income, remember the American housing crisis? The average American at the time of the housing crash was spending levels lower than this at around 145% of income. Interest rates are low so people are borrowing and spending like crazy and it might come back and hit them. Canada's total household debt is just barely below $2 trillion and 65% of this debt is mortgages. This makes me think of the Big Short when Mark Baum is talking to the stripper and finds out she has taken out numerous loans and owns 5 houses and a condo. Some anecdotal evidence to this is I know some people in the same or similar situations.

This situation is worrying but it is reassuring to hear that default rates are not bad here, yet. Delinquency rates are on the rise in Canada. Taking into account late payments on credit cards, car loans, and mortgages, delinquency rates are have increased when comparing 2016 and 2015; although the level is still not too high and just below 1%. This is still an interesting trend to note and perhaps should be the most important one to follow if you truly believe the Canadian house market will collapse. Follow the delinquency and default rates, particularly on mortgages.

Another key feature I want to share is bank strength. Canadian banks have been longingly touted as some of the strongest banks in the world. This is true, or was true, the trends are reversing though. In a time like this where there is a lot of market uncertainly, and everyone are on their toes, regulators want to see banks have stronger assets that are more liquid in the case of turmoil. Look at Deutsche Bank getting hammered in stock price because investors do not believe their assets to be solid as a large portion of their assets are level 3 assets which include derivatives and assets that are hard to value and highly illiquid. Now take into consideration that Canadian banks have below average leverage ratios that stand at around 3.9 and they are considerably behind American and European banks. This ratio includes a lack of level 1 assets which are highly important to fall back on incase of market uncertainty and a crash. In addition Canada's largest banks are heavily invested in Canadian mortgages.

Another thing I have been thinking about is the risk of global contagion. It is hard to measure or predict just how exposed the Canadian market in general is to global consequences. I am leaning over to being skeptical as a whole on the international market. What happens if Deutsche Bank collapses? What happens when the States raise the interest rate? What happens when Britain enacts Article 50? What happens if companies continue to post horrible earnings for the considerable future? There is a lot of factors to consider if you want to short the Canadian housing market or the markets in general.

So what are we working with?

As I mentioned before I don't recommend the headache of credit default swaps and the fact that many will fall under capital requirements, among many other reasons. But, perhaps you want to throw a couple bucks at bear ETFs that have Canadian real estate exposure. Or maybe you would prefer to short a Canadian mortgage investment company. There has been considerable interest in shorting Bank and MIC stocks in Canada the past year for example.

The bottom line is that something is cooking in the Canadian Real Estate market and it doesn't smell good.

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it. I have no business relationship with any company whose stock is mentioned in this article.