The “soft landing” that Bank of Canada Governor Stephen Poloz still predicts for the housing market conjures up thoughts of powdery snow and fluffy pillows.
No bumps. No bruises.
But the threat of something more painful is growing.
Alberta’s real estate market appears to be in the early stages of a correction as the falling price of crude ripples through the province’s economy. Many homeowners are rushing to sell while they can, buyers are increasingly scarce, and prices are faltering.
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The worry is that Alberta’s problem will infect the rest of the country as the weakened economy destabilizes a real estate market that is overvalued by as much as 30 per cent.
Mr. Poloz has acknowledged that stretched household finances are a big reason he cut the bank’s key lending rate last month. Economic modelling by the Bank of Canada indicated that, without lower rates, the falling price of crude would hit households hard, pushing the closely watched debt-to-disposable income ratio up four percentage points to a new high of nearly 167 per cent.
It may be hard for Canadians to imagine what a housing correction looks like, let alone a crash. House values have been on a steady upward trajectory in most of the country since the mid-1990s, swelling the wealth and borrowing power of Canadians.
Crashes are ugly. They are not soft.
On one block of palm-tree-lined Ramona Street in Miramar, Fla., an outer suburb of Miami, nine out of 37 homes were in some stage of foreclosure in early 2008. Boarded-up houses and for-sale signs were everywhere in this neighbourhood of 1960-vintage bungalows.
When the dust settled, prices across the United States had fallen more than 30 per cent.
A U.S.-style crash here is unlikely. The U.S. real estate market fell hard and fast because communities like Miramar became all too common – places where home buyers quickly found themselves owing more on their mortgages than their homes were worth. As prices tumbled, more than 30 per cent of U.S. homeowners with a mortgage would eventually wind up underwater – a problem fuelled by excessive leverage, tax breaks on mortgage interest and lax lending standards. And because bankruptcy laws in many U.S. states prevented banks from seizing homeowners’ other assets, many people simply walked away from their mortgages and their properties, sticking lenders with millions of foreclosed properties.
The Canadian market is different in a number of important ways. Very few Canadians are at risk of going underwater on their mortgages because they generally have more of their own money invested. On average, Canadians have 74 per cent equity in their homes, and for those with mortgages, it’s 49 per cent, according to a November, 2014, report by the Canadian Association of Accredited Mortgage Professionals. Three per cent of homeowners have less than 10 per cent equity, and 1 per cent are underwater.
Those ratios, of course, are dependent on prevailing prices, which are almost certainly inflated. But Canadians are clearly more insulated from a market downturn. That is not to say a serious correction isn’t possible.
The main risk in Canada is not a sudden decline in house prices. It is household finances. Falling incomes or higher interest rates would put a significant share of homeowners in distress. In some cities, a retreat of foreign investors in Canadian real estate could also take some of the froth out of the market.
Lower borrowing rates in the short-term may just put off the inevitable, perpetuating an unsustainable mix of less saving and more borrowing, argued Merrill Lynch economist Emanuella Enenajor. She worries the Bank of Canada will cut rates again in March, setting up the economy for “slower growth once the adrenalin shot fades.”
The housing market is headed for a “narrow” regional shock – an 8-per-cent annual price drop in Alberta, but higher prices in Ontario and Quebec, she said.
In the end, the housing correction in Canada could look more like a bumper car ride than a crash. With incomes stagnant, it could take years for homeowners to work off their debts, and for buyers to afford homes at today’s inflated prices.
The landing may be soft, but far from comfortable.