Is Canada's residential real-estate market finally starting to crack? That's the question homeowners and equity investors are surely asking themselves after hearing about falling home sales in Vancouver. According to the Canadian Real Estate Association, home resales in the Greater Vancouver area dropped by nearly 19% month-over-month in August, while the average home price in the region fell by 18%. That was in large part due to the 15% tax on foreign home-buyers that came into effect that month. However, the same report found that national home sales fell by a 3.1% annualized rate in August compared to July.
Naturally, these numbers are worrying to anyone who's in the market for a home and to investors who might be imagining a U.S.-style, housing-fuelled recession in the near future. Whether we'll actually see a crash in both real estate and stocks, though, is still difficult to predict. That said, Eric Lascelles, chief economist with RBC Global Asset Management, says the market hasn't been this precarious since the global recession. "We think we're at an inflection point," he says.
By Lascelles' estimates, at the current interest rate, the housing market is overvalued by 35%. Some parts of the country are even more overheated than that. Despite the falling numbers in Vancouver -- a cooling that began in February -- prices in the area are up 26% year over year. According to Teranet's house price index, prices are up 15% in Toronto over the same time period. "That's a steep rate of price inclines," says Stephen Lingard, a portfolio manager with Franklin Templeton Solutions. "We have a bubble brewing."
So what will cause prices to decline? It won't be a rate hike; in fact, Bank of Canada governor Stephen Poloz said on Sept. 20 that "we need to prepare for lower (rates) for longer." But it might be regulation. If the foreign-buyers tax does indeed lower prices, other provinces could follow suit with a similar tax or perhaps some other piece of price-lowering legislation. "There is precedent," says Diana Petramala, an economist at TD Bank.
Something else could derail housing prices: higher unemployment. This is what's happening in Alberta, where job losses are at record highs and year-over-year housing prices in Calgary have fallen by 4.5%. While the Canadian job market has looked weak this year, with about 8,000 new jobs a month having been created over a six-month average, most economists don't think we'll see Calgary's woes play out elsewhere in Canada. Oil is stabilizing, and Ontario's manufacturing sector, while not nearly as hot as economists had thought it would be by now, should pick up speed thanks to the still low loonie. Still, this is a risk given Canada's sluggish economy.
Lascelles says there are three ways the housing market could go. According to his calculations, there's a 30% chance that nothing will happen and prices will keep rising, a 40% chance that the housing market will go sideways and slowly resolve its issues, and a 30% chance of a serious double-digit housing correction. While the latter scenario isn't as likely as the second one, he's never had a higher probability on a market crash before, he says.
Investors do need to keep in mind that housing is, in large part, a regional issue. While people often talk about national figures, a crash may occur only in Vancouver and Toronto. Petramala thinks Vancouver prices will rise again in the short term, as foreign buyers could figure out a way around the tax, but prices will still fall by about 12% over the next year. That's largely driven by just how fast prices have accelerated there. Toronto is about year behind Vancouver, she says, which means the former will start seeing prices slow sometime in 2017. She also believes Calgary, Regina, Saskatoon and Edmonton will see more weakness due to oil-related unemployment.
In other markets, like Winnipeg, prices are not at inflated levels and shouldn't experience big movements going forward. However, as we've seen in other sectors, like gold and energy, market sentiment is a powerful thing. If the average person continues hearing about Vancouver's dropping prices, and if Toronto's prices follow suit, people across the country may start putting in lower offers or putting off selling their house. "There's more demand than supply right now, but that can change on a dime if we have a sentiment shift," says Lingard.
If this is indeed the beginning of a housing downturn, or even a stabilization of prices, as Lascelles thinks, some sectors will be affected. The biggest risk is to banks, which have been issuing more loans as prices have climbed. In June, Moody's warned that if prices fall by 35%, the country's mortgage and banking sector could lose $17 billion, while the Canada Mortgage and Housing Corp. (CMHC) could be responsible for $6 billion in losses.
A decline would also affect construction and building companies and consumer spending. Fewer people moving means fewer people buying items for their homes. Housing prices also create a wealth effect; people feel wealthier when values climb, and vice versa. If prices drop, people may start reining in their spending, says Lingard.
While many economists think the market is teetering more than ever before, most expect more of a soft landing than a hard one. Lingard's base case is that we'll just muddle through, while Lascelles is expecting things to move sideways. Now's the time, though, perhaps more than ever before, to be aware of what could happen if prices fall further. Consider moving some money out of Canadian banks, diversify internationally and hold on for what could be a bumpy ride.