It wasn’t supposed to be like this. Our recovery from the Great Recession happened faster than expected, we got in the mood to buy again, and the housing market spontaneously returned to bidding wars and double-digit gains. Experts say we’re in a bubble that’s ready to pop. The question is, how bad will it be?
Christopher Wahl
We’ve seen bubbles before. The last time the market went pffft was in the spring of ’89. The country entered a deep recession, mortgage rates hit 13.5 per cent, and the market was glutted with condos that speculators couldn’t off-load. Over the next seven years, the price of resale houses downtown dropped by 28 per cent. Owning a house was a burden.
The birth of the current bubble-like conditions can be traced back to 2008, when we smugly discovered our market was safe from the financial evils that led to the housing collapse in the U.S. We were intoxicated by good news: speculative investing was comfortingly low, our interest rates dreamy. Neighbourhoods like Parkdale, the Junction and Leslieville were lusted after by young couples and families in want of $400,000 fixer-uppers. The upwardly mobile had ballooning debt and stars in their eyes. Among the singles flooding into sparkling new condominiums were women in their mid-20s to late 30s, a boom demographic. One industry source estimated that they represented 40 per cent of the market, significantly higher than a decade before.
Demand was also driven by new arrivals. Everyone wanted to live here: almost half of the 250,000 people who immigrate to Canada each year settle in the GTA, and for many, the natural course of events is to plant roots by buying fairly inexpensive condos or suburban starter homes—affordable by international standards. For a big city, Toronto was a safe investment and a relative bargain.
Prices briefly flatlined in 2008, the same time city hall doubled the municipal land-transfer tax (which added as much as $10,725 to the cost of a $750,000 property). But the party raged on, and by last July, with Mark Carney declaring the recession technically over, the market resumed its climb. Even the high end rebounded: in Toronto, more than 2,300 homes with a value of over $1 million sold in 2009. From last fall through the early spring of this year, sellers did extremely well—particularly within the high-demand $500,000-to-$1-million range. Buyers, however, had to endure adrenalin-pumping condition-free offers and bidding wars. “I’ve been selling real estate for almost 20 years, and that was the craziest the market has ever been,” says Kara Reed, an agent at Chestnut Park. By the end of the first quarter of this year, the average house price was $427,948, up from the 2009 average of $395,460.
The warning signs of an impending pop are plentiful. The banks, inspired by the perkier economy, began to push their rates up. Jim Flaherty, in a fit of finger wagging, rolled out new CMHC rules that effectively ended real estate speculation by requiring buyers of non-owner-occupied places to make a minimum 20 per cent down payment, up from five per cent, to qualify for insurance. Then Carney announced a possible Bank of Canada rate increase by early summer, signalling the end of extreme low-interest debt. Unless we fall into unforeseen economic peril, rates will only go up from there, likely to double digits by 2020. When current five-year terms come to an end, those borrowers among us who bought houses they could ill afford on 35-year amortizations will either have to find extra money somewhere or they’ll be forced to sell.
While most economists, brokers and market watchers agree the bubble won’t continue to inflate, they’re divided on the severity of what happens next.
All the doom & gloom and negative media types have been calling for the POPING of the bubble for the longest while. Why is the media hoping and wishing for the same? You just overhype the issue and sensationalize everything with our real estate market instead of praising canada & this great city. Let the axe fall and we do adopt prudent lending practises to whether the storm. Will it be bad as the US, I dont think so and will it happen – yes – but not as dramatic as you nay sayers believe and constantly tout. Geez.. EH?
July 6, 2010 at 10:58 am | by PeeAnyone who bought in the last several years, no matter which neighbourhood they chose, will not come out ahead. Housing is in a bubble — not the same as the U.S., but similar enough that we should be able to predict the outcome.
Low interest rates inflate housing prices. Period. When rates rise, prices will fall. Contrary to shameless realtor pumping, buying when interest rates are low is the worst time to buy a house. As rates they rise, your equity disappears.
Government incentives and no-risk lending (CMHC) drew the riskiest of borrowers into the housing market. Zero percent interest rates got the last remaining. But Canadian banks don’t lend to risky borrowers you say?
Suppose you had $1M sitting around. Someone came to you and said, “I graduated university 3 years ago and lived with my parents. My wife and I have saved $50K and we want to buy a house. We’ve always paid off our credit cards so we have good credit ratings. Will you lend me $950,000 at your lowest interest rate?”
You’d probably tell them to go suck an egg. You wouldn’t want to potentially lose money if they got sick/divorced/lost jobs/went bankrupt on such a high ratio loan.
Even if they sold later for the same price that they bought, that 50K would be eaten up by Realtor fees, legals and taxes, so their down payment is worth nothing. If the markets reverse, even by as little as 10%, you’d be potentially out more than $140,000.
But when that exact same person goes to a bank, the bank loans them the money. Because if the borrower defaults, the bank gets paid anyway. That’s because we pre-bailed-out our banks by guaranteeing loans in advance.
And that is why the Canadian banking system was considered “prudent” : because the government assumes all the risk.
Why wouldn’t they take the guaranteed profits? Wouldn’t you?
We are now at a point where the most marginal buyers have bought. With the tightening of rules on April 19, there are simply too few potential buyers left to keep this market afloat. The smart money is out. And the dumb money is already spent.
As if that weren’t bad enough, here’s where it gets hairy. Canadians are in love with their home equity and real estate in general. Once upon a time, so were Americans, Japanese, and Englishmen.
So much so that they borrow against it, reasoning that they can’t get lower interest loans than they can on their homes.
Banks can still get CMHC insurance against those home equity loans, so they’ve been loaning like it’s going out of style, adding billions of leveraged dollars into the Canadian economy.
When the market corrects, that equity will be gone. But the debt will remain. And there will be less to borrow against at higher interest rates.
The whole Canadian economy will suffer. Instead of buying books and furniture and Toronto Life subscriptions, Canadians will be stuck paying back their debts from the 2000s and double the interest rate.
This bubble has tried to correct itself several times since 2003. Every time the market starts to stall out the government has loosened rules and lowered interest rates, sucking in more buyers and delaying the inevitable.
It’s now at the point of no return. Rates will rise. Lending restrictions are already tightening. Unless the government loosens rules further (doubtful) prices will finally give way and normalize.
Make no mistake, real estate is about to collapse and you’ll pay for it twice: first with your own home equity and second with your taxes through the gov’t guarantees made to your fellow Canadians.
If you need to sell int he next 5 years and you haven’t sold yet, do it now (July 2010). This market is not coming back.
If you’re looking for advice, there’s no reason to ask any of your traditional sources. The nice lady at the bank wants to sell you as much mortgage as she can for guaranteed profits. The real estate agent makes money from the sale, and so does your mortgage broker. Even the government has a hand in it, because they insure the loans.
It’s very unpopular to tell 70% of Canadians (who own homes) that they’re about to take a bath on what many of them consider to be their best investment.
I know that to you I’m just an anonymous poster on a magazine’s website. And you have probably already branded me as a pessimist.
You don’t have to believe me, just do the math. Rigourously.
The conventional wisdom that buying a house is always a good investment, while once right, is now wrong.
Calculate how much it will cost you in TOTAL for that house (include property taxes, maintenance, repairs, 2 land transfer taxes, realtor fees, interest cost, investment return on your down payment). Is it really cheaper than rent?
If you’re doing the math right, in Toronto, in 2010, it is not.
July 6, 2010 at 11:48 am | by Don't do itto the above poster-
Don’t do it: great response to the article
i hope people take the time to read your comments
and why wouldn’t they, what do you have to gain by dissuading them from buying an overpriced asset (which can turn into a liability real quick i might add)
you’d think that if real estate is such a good moneymaker right now, then other people would be trying to convince you NOT to buy so they can make more money themselves, right?
July 7, 2010 at 12:05 am | by think about itKudo’s to the people that flogged their 90 year old brick 2 storey for 900,000+
July 7, 2010 at 4:34 am | by piccasoTo bad, so sad for the sheeple that bought these fixer uppers and spent another 100,000+ on reno’s.
@Don’t Do It
Your comment nails it. Succinct, logical and timely. The only people that don’t want to believe it’s a bubble are those with a lot to lose.
July 7, 2010 at 6:01 am | by Patiently WaitingWho cares what a home is worth once you are settled into it? It is your home not a money making machine. The housing market turned into the stock market thanks to the many institutional predators that got personally rich. Thanks to our Finance Minister and his Central Banker. Greed,envy and dishonesty manipulated the market. We turned the housing market into the stock market. But of course it is different here than the U.S.
July 7, 2010 at 3:53 pm | by Anonymous@Anonymous,
You said, “Who cares what a home is worth once you are settled into it?”
Let’s look at two hypothetical families to see why they would care.
Remember, people move for all kinds of reasons. Death, divorce, marriage, babies, job loss, relocation, better schools, more space, you name it. Maybe you’re just sick of your house. Sometimes you have a choice to move. Other times you don’t.
—-
Young couple, put 10% down on a 400K house.
Market drops 10%.
—-
If they want to sell that house (job change, job loss, divorce, baby, change schools, etc) they have to show up on closing day with a $20,000 cheque (realtor fees + HST). If they want to buy a slightly bigger house, they’ll need $16,000 more (land transfer taxes, legals etc.) That’s $36,000 in cash on hand just to move.
For this young couple, 36K is probably pretty hard to come by. And that 36K is pure cost; it builds zero equity.
But wait there’s more! They’ll need another 5% to put down + CMHC fees on the next house if they want to “stay on the property ladder”. Or pay penalties for breaking their mortgage if they choose to rent.
And if they rent? That’s one more buyer out of the market, driving prices further down.
“But they still have the house. They can stay and not worry about it.” Provided their circumstances allow it and they don’t want to move for at least another 7 years, that may be true. But here’s the catch: with no home equity (or potentially being underwater), they bank will not budge on their interest rate. They also won’t be able to change lenders. That means this couple gets the posted rate.
Today the posted rate is 6% which amounts to about 1.5x more interest than they’re paying now.
Can they still afford to live in that house? Can they afford to move? What if interest rates go up? (hint: they will.)
A 10% correction for this couple is check and mate.
—-
Middle aged couple, 25% equity in their house valued today at 600K
Market drops 10%.
—-
This couple has a healthy amount of equity by today’s standards. Not too long ago, 25% would have only had just a regular down payment. No matter.
If they want to move to another house, a market drop of 10% will shave their 25% equity down to 16% right off the bat (ie, $90,000 on a $540,000 house.)
In order to get that equity out, they need to pay a realtor 5% + HST, about $30,000, whittling this couple’s equity down to $60,000.
Assuming that they want to move to another house that’s exactly the same size and price, they’ll need an additional $22,000 for closing costs*.
That leaves them with $38,000 cash, or a 7% down payment on their next house.
The sting of 25% -> 7% isn’t something most people take lightly.
In dollar terms, they went from $150,000 in equity down to $38,000 with just a 10% drop for a total loss of $112,000 after tax dollars on that investment.
Again, if this couple doesn’t buy another house, that’s one more buyer out of the market, driving prices down further.
As a side note, all of these costs are pretty conservative. These people haven’t paid penalties for breaking their mortgage (which they probably would), they haven’t had interest rates rise on them (which they will), and they haven’t paid moving costs or other incidentals. These numbers can get pretty nasty pretty fast. And I haven’t even calculated in the loss from the initial land transfer tax when they bought or the interest cost for the mortgage or the property taxes and maintenance they’d been paying all those years.
To top it all off, housing corrections are typically very slow (last year excluded — the real reasons for that ‘recovery’ can be left for another day). This is going to play out over years, not months.
Brace for it. It’s coming.
So, “Who cares what a home is worth once you are settled into it?”
You do.
~~~~
July 7, 2010 at 5:58 pm | by Are you kidding me?* Closing costs calculator used: http://www.integratedmortgageplanners.com/mortgage-calculators/closing-cost-calculator
I think we are ready for a bubble bursting in Toornto. These prices are crazy. How can newlywed couple afford a house these days? With the money in my house I am looking at the deals down south. At up to 75% off, I can buy several places, make yearly profits and benefit from the appreciation in a few years. There are seminars all over the city showing this. I am going to one tonight ownfloridanow.com .
July 8, 2010 at 9:56 am | by Mee@Mee: Best of luck. I’m sure that there are lots of deals available in Florida right now, but be sure to get advice from someone who knows what they’re doing in that market who doesn’t have a vested interest in selling you properties.
You’ll also need to know that as a non-Florida resident, your property taxes will be significantly higher than a Florida resident’s. The climate down there will affect your maitenance and carrying costs significantly. And Canadians buying mortgages should know that there are different laws in the US and qualification procedures may be quite different as well.
The glut of inventory in Florida right now may make renting your property out harder than you may expect.
There are lots of wealthy Floridians who know their market inside-out. As a foreigner, you may not have the same insights they do available to you. Make sure you ask yourself why they haven’t snapped up these properties before you got your hands on them before making your investment.
Good luck!
July 8, 2010 at 10:05 am | by Are you kidding me?Must be nice to be able to afford your own. There are many who cannot including myself so I don’t feel sorry for anyone wanting to buy. With not many subsidized housing going up and some of it the budget will inevitably be slashed so run down buildings given to TCHC will still be dumps. Regular apartments at extortionate prices for horrible places will keep having revolving doors at the front when people realise the dump that looks nice at the front isn’t all it is cracked up to be.
July 8, 2010 at 4:52 pm | by stellaMyself like half the population of Toronto will never be able to afford their own home let alone an apartment. Again for people able to buy I don’t pity you, sorry.
I feel more apathy towards people like myself and people who are worse off or on the street not by choice.
What is this preoccupation with a home-ownership? It is just
July 8, 2010 at 5:49 pm | by Reasonbunch of bricks and drywall. Why would any one own such an expensive anchor?
People that go into multi generational debt(slavery) over a bunch of bricks should have their head checked by a shrink.
July 8, 2010 at 5:51 pm | by ReasonReal estate agents get paid far too much for what they do. $12-16k on a $300k condo to post an add on mls and wait. Sickening!
July 9, 2010 at 4:17 pm | by FlowersformommaDon’t Do It. Let me guess, you don’t own a home in Toronto. However, you have been hoping for the bubble to pop for years and are quite frustrated that it hasn’t and are now priced out of the home that you would consider decent. :) It’s certainly understandable that you’re hoping for a crash but the likelihood of a full-on massive correction is over stated and unlikely.
First, interest rates are still low and although they will go up, they won’t increase dramatically. The Bank of Canada can’t simply raise rates with reckless abandon as that would risk our economic recovery. Remember, the rest of the world is not recovering like Canada so we need to be prudent when raising rates.
Second, the employment situation in Canada is improving. The unemployment rate has gone down and far more new jobs than expected have been created. In other words, people can afford their homes, even if rates rise gradually in the coming years. As a result, there won’t be a panicked sell-off of homes like in the US.
Third, the economic conditions of the 80′s housing crash are drastically different than now. They went into a recession and had very high borrowing rates. We don’t have those same conditions now.
Last but not least is that supply on the market is increasing but there will be buyers as long as it’s not a glut of supply. It’s unlikely there will be a supply glut because as mentioned above, there won’t be mass panic to sell. Homes in Toronto, especially the older established homes have solid value and will be sought after by locals and international investors alike.
What will more likely happen is that the market will return to a more balanced state. Sellers won’t get astronomical prices, bidding wars won’t be the norm and there will be a sense of reasonableness on both sides of the transaction. House prices will stabilize, maybe dip a bit but then will return to slow growth going forward.
Unfortunately for those hoping to get a city home for fire sale prices are just going to have to move to the US ;)
July 10, 2010 at 6:00 pm | by Freakanamikes@Freakanamikes,
Thanks for the reply. I don’t own a home in Toronto because it’s cheaper to rent one. No more emotion goes into it than that. It has nothing to do with affordability. Do the math and you’ll discover it’s cheaper by about half to rent. I’m not one to turn down a 50% discount, are you?
My landlady could make a slightly more money than I give her in rent by selling this house and putting it in GICs (after her costs) with zero risk.
Why is she taking all this risk, paying insurance and taxes, fixing and repairing the house I’m living in? I won’t complain, but I do wonder.
My guess is that she doesn’t know she’s even subsidizing me. She hasn’t thought about it hard enough or done the math. In reality, without knowing it, she’s actually both speculating that prices will continue to rise and subsidizing the roof over my head.
To your points,
1) Eventually the stimulative effects of low interest rates and easy financing wear off. That’s because eventually, enough demand is pulled forward by low rates that there are fewer buyers than there are sellers and supply overwhelms demand. Then prices fall. Are we at that point? I don’t know. But an all time record >70% of Canadians own their homes and 13% live below the poverty line, so it can’t be that far off.
Loaning money for less than inflation (a negative real-return on funds) is not sustainable. Interest rates will rise and when there’s even a whiff of inflation on the horizon, and they’ll rise fast to at least normal levels.
Remember that the Bank of Canada couldn’t care less about your mortgage affordability. The BoC cares about inflation /growth and uses interest rates to keep it close to its inflation target.
2) Improving employment means an improving economy and the potential for more inflation, driving interest rates up. Low interest rates and loose lending standards are why you saw the greatest boom in Toronto housing history during 10% unemployment.
The reason interest rates were dropped to zero in the first place was to combat deflation. Once that threat is gone, rates must normalize and again, the bank could not care less about your 5% down 35 year mortgage. They only care about monetary policy.
People can afford their homes if their incomes rise along with interest rates. With such low rates today, in order for incomes to keep up with interest rates rising, your income would have to increase 9% to offset a 1 percentage point rise in the interest rate — compounded! Do you raises look like 9% per year for the next few years?
3) In the 80s (late 80s, early 90s), Canada had a runaway deficit and serious inflation. That forced up interest rates. Again, when rates rise faster than incomes, prices have to give, and so they did. It happened in the 80s and it will happen again in the 2010s.
4) Gluts of supply take time to build. I *believe* that April 19 was the turning point (new CMHC rules), and you’ll notice that supply started to build shortly thereafter.
I don’t have a crystal ball, so I don’t know when the point of capitulation will be. But I do know that this is simply unsustainable. What cannot be sustained will not be sustained. A correction can no longer be avoided because interest rates only have one direction to go. The only question now is the timing.
Curiously, you said that the market will return to a balanced state. If it’s been unbalanced for a decade (ie, strongly favouring sellers to the point of bidding wars and waiving inspection clauses) what makes you think that balancing wouldn’t mean a decade of favouring buyers with lower prices? Isn’t that how balance works?
It sounds like you who have an interest in this market, either for professional reasons or because you own property. I don’t have an interest in this market at all. If I can continue to rent the same house for less than it costs to own, I will rent. When prices normalize and it’s more cost-effective to buy, I’ll buy. Simple as that.
I don’t really care which way the market goes. I’ll take 50% discounts where they’re offered.
If this is just an ideological point for you and you think that housing is the only thing in the world where prices can only go up, then I can’t argue with that but instead simply disagree. The same goes if you’re buying a house for an emotional reason.
But if you’re looking at it from a financial view and you can open your ears and do some calculations and put emotion aside, you’ll find that by every metric, Toronto’s housing market is significantly overvalued.
I hope that a few people who are reading these comments go to the trouble of running the *real* numbers, especially younger families with 5% down. It could be the most important calculations they’ve ever done in their lives.
July 10, 2010 at 11:49 pm | by Are you kidding me?