Canadian Housing: The Big Short 2.0?

August 15, 2016

In this article, I will discuss:

1. Background information on Canadian Housing

2. Why this bubble is going to end awfully 

3. Why this bubble won't be The Big Short 2.0

 

Why are people saying Canadian Housing is in a Bubble?

 

This is simple:

  • In June, the number of one (a.k.a single)-family homes over $770,000 rose by 25% since last June. Now, roughly 90% of one-family homes cost this much.

  • Even with oil prices plunging and first-quarter GDP growth coming in at 0.4% lower than the consensus estimates, this sluggish economy could still not cool down the housing market. In June, housing prices experienced year-over-year growth of more than 11% when compared to last June. 

  • Limited housing units paired with low interest rates are raking in floods of foreign capital. Specifically, China is a big buyer of Canadian real estate. Chinese buyers are using loopholes within their own country to transfer large sums of money into Canada (and other places like Australia). Although only 8-10% of houses bought in the Metro Vancouver area are by foreigners, Bank of Canada Governor Stephen Poloz and other Canadian politicians are still concerned that high real estate prices are due, in part, to these buyers (particularly the Chinese).

Why will this bubble end horribly?

 

This is a bit more complex:

  • People who live in China are only allowed to transfer $50,000 out of the country annually (Government restrictions). However, Chinese buyers are using loopholes to purchase real estate in Canada and other nations. The people of China are combining friends and family's annual privilege and are using this combined money as down payment for Canadian real estate and are using mortgages for the remaining payment. The Chinese media is already making this bubble seem worse than what the Americans faced. However, I believe the Chinese Government will crack down on these loopholes and shut it down to reserve capital for their own country.

  • In fact, the pop is already beginning. The amount of housing starts (number of houses built during x amount of days) decreased by roughly 9.13% from June to July. To me, this indicates that Canadian housing prices have become too expensive for the working-class individual or family to afford. As a result, I believe Canadian housing companies will reduce their real estate prices to prevent any public and/or governmental complaints. I also believe these prices will decline so that mortgages will not be viewed as lifelines or another source of income (just like how U.S. citizens did in 2007). 

  • Even with 0.9% growth in the Canadian person's average weekly income from last year, over half of the major Canadian sectors suffered a wage decline. This decline is very significant. In 2015, the debt-to-income (DTI) ratio of Canadian housing debts was more than 15% greater than in America before the financial crisis. The Canadian DTI ratio is over 165%. This means that housing debts (specifically mortgages) are exceeding peoples' income by 1.65 times (i.e. 82500 in debt/50000 in income = 165% DTI ratio).  To me, a high DTI ratio (especially in housing) indicates that banks are giving loans (particularly mortgages) to anyone regardless if their income is too low to pay it back (just like the high DTI ratio in American housing before 2007). So, lower wages means lower income, thus resulting in a higher DTI ratio. Canadian banks have already implemented strict policies on who they give loans to, but they are (currently) not strict/enforced enough. They are undermining the fact that they are following the formula of pairing declining income (lower wages) with increasing debts (a.k.a giving more loans). This same formula led the U.S. to one of the worst financial crisis in history. I think it's only a matter of time before peoples' debts become too much for them to handle.

 

Why is this bubble not the next "Big Short"?

  • At its core, the financial crisis of 2007-2008 came down to the immense amount subprime mortgage loans in the market. These were the loans that many people could not pay back and, as a result, caused many bank and housing stocks to plummet. According to a Harvard study, 20% of mortgages in American from 2005-2006 were considered to be subprime. In 2015, only 5% of all Canadian mortgages were subprime. Since I believe that subprime mortgages were the cause of the crisis, and since Canada has so little of them, I don't think that Canada will be "The Big Short 2.0". Although I don't believe that this bubble is like the U.S. in 2007, I do believe that Canadian banking and housing stocks will face major declines within the next year or two.

 

 

Please read my disclaimer before taking any financial action.

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