Bubble Trouble

There are two main schools of thought when it comes to the real estate sector in Canada.

One, that homes are overpriced in major Canadian cities like Toronto and Vancouver, but that’s a just product of our economic reality — cheap credit and globalization. Real estate optimists see the growth of Canada’s housing sector as a sign of economic health, an inevitable result of people’s ability to borrow at such low rates, and the attractiveness of our cities as places to live and invest in. Nothing to worry about here.

The second school of thought is a tad darker. It too believes that Canadian homes, particularly in the urban centres of Toronto and Vancouver are vastly overpriced, and that these prices aren’t sustainable. In fact, not only are they unsustainable, they rest on the back of over one trillion dollars in household debt — a number that is still growing, albeit at a slower rate than it used to.

Debt: A Canadian Identity

“The ability of domestic home buyers to continue to accumulate record levels of debt is going to be a big problem going forward,” says Ben Rabidoux, President of North Cove Advisors, a market research firm specializing in Canadian housing and credit trends.

“There’s more household debt in this economy than we have ever seen. This is not sustainable.”

The crux of Rabidoux’s pessimism centres around the extent to which be believes Canadians are indebted. According to Rabidoux, out of $1.99 trillion in overall household debt, $1.43 trillion consists of residential mortgage debt. He believes that’s a troubling number because average incomes in Canada have been flat in the last year — not nearly enough to justify the way Canadians continue to pile up on mortgage debt.

Hilliard MacBeth, author of When the Bubble Bursts: Surviving the Canadian Real Estate Crash says that for the current prices of homes to be justified, especially in cities like Toronto and Vancouver, incomes would have to rise 40-50 percent, at the very least.

“The rule is you should not take on a mortgage more than three times your income. So if you earn $75,000 in a year, your mortgage should not exceed $225,000. But I see young, first-time home buyers earning less than $70,000 being offered mortgages at least six times their income. How are they going to pay all that money back?” MacBeth says.

Truth be told, you could very well continue to make your mortgage payments if the status quo persists. Low interest rates mean that your payments aren’t very high to begin with, and if you’re in a job that’s full-time and stable, you’re good to go. The problem arises when any one of those factors changes.

“If interest rates go up, which they will pretty soon, banks will have to start charging the real cost of a mortgage. That could mean that you’re paying 4-5 percent in interest on a mortgage, instead of 1-2 percent. I’m doubtful as to how many people, young people especially, will be able to afford those bumps in monthly mortgage payments. You’re cutting it too close,” says MacBeth.

Much Ado About Nothing

For years, housing bears like Rabidoux and MacBeth have been criticized for their overly negative view of the housing market. Their detractors argue that despite predictions of a crash, Canada’s housing market continues to outperform expectations, especially in cities like Toronto, where average prices in the last year surged a whopping 20 percent. They say talk of a crash is hyperbolic and frankly, unrealistic.

“I think it is way too bearish,” CIBC’s deputy chief economist Benjamin Tal told VICE Money. “I’m sure that many young families would love to buy homes. In Canada, we have this attitude that there’s something wrong with you if you rent. We have to get more used to the idea of renting since housing has become very expensive.”

Tal’s whole point is that the phenomenon of pricey real estate in Toronto and Vancouver is a natural product of rapid economic growth in those cities. “The condo market is playing some role in providing affordability, and that’s the nature of living in a big city — you have to downsize.”

I ask Tal about the debt issue, and while he acknowledges that Canadians will indeed feel the pinch in the event of a rise in interest rates, he’s sure that it won’t lead to a wave of massive defaults, only because the pool of people who have leveraged themselves up in mortgage debt isn’t as big as Rabidoux and MacBeth make them out to be.

Crash Scenario

Neither MacBeth or Rabidoux were willing to place bets on just when Canada’s housing market would begin its rapid slowdown, but they both warn of the consequences of a crash.

“Real estate services and construction was the fastest growing sector in Canada in the last five years. Our economy is leveraged on this sector, so consequences of a crash go far beyond individuals who own homes. It could result in a whole bunch of job losses,” says Rabidoux.

There’s also the additional factor of non-bank loans — mortgages that Canadians have taken out from alternative lenders. These mortgages usually have favourable lending terms attached to them, because lenders are banking that the value of the collateral (the property) will keep increasing. As soon as that ends, says Rabidoux, you’ll start seeing non-bank lenders pull their mortgages from people.

“I always say, focus on future prices,” Macbeth told VICE Money. “If you’re taking out a mortgage that you can’t afford, and you’re relying on the ever-inflating housing market to eventually pay off that debt, you’re in for a huge shock when the market corrects itself.”

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