Thursday, December 13, 2012

Canada's Real Estate Market is not an Island


Scotiabank's most recent examination of the global real estate market helps put Canada's current marketplace into context and shows us how we are living in a relatively unique situation, one that is unlikely to continue if we observe what has happened to residential real estate in the rest of the developed world.

Here is a bar graph showing the year-over-year changes in real house prices for 19 world markets:


In the third quarter of 2012, Canada's year-over-year price change sits right in the middle of the pack with a decline of 1.5 percent as reduced demand and reduced affordability finally caught up to the market, particularly in two major centres.

Let's open by looking at the real estate market in Europe, keeping in mind that the Eurozone is in recession and unemployment hit a new high of 11.7 percent in October.  You'll notice on the bar graph that Ireland and Spain have seen the greatest year-over-year price drops, down 14 percent and 12 percent respectively.  In total, since the peak in 2007, Ireland's property values have dropped by 52 percent and Spain's have dropped by 33 percent.  In the third quarter, on a year-over-year basis, France saw a 3 percent price drop and Italy saw a 5 percent drop.  On the upside, prices in the United Kingdom declined by only 1 percent, the lowest decline rate in more than two years.

Here is a graph showing inflation-adjusted housing prices for Ireland, the United Kingdom, Spain and France:


In the Asia-Pacific region, Australia's house prices fell by only 2 percent on a year-over-year basis, largely on the country's economic strength related to its natural resource-based economy and demand for its products from China.  Adding to the upside, the Reserve Bank of Australia has cut interest rates by 1.25 percentage points.  Unfortunately, despite minor downward price adjustments, Australia's residential real estate prices remain stratospheric when measured against median household income.  Property prices in Japan continue to fall in response to an aging and shrinking population.  India's housing market is weak with prices falling for the second quarter in a row.  China is also experiencing a modest downward price trend as the central government reigns in property values through limits placed on homeownership.

Now, let's look at the housing market in the United States.  Real home prices rose by 5 percent on a year-over-year basis in the third quarter of 2012 but prices are still down 30 percent from their peak values as shown on these graphs:


Sales are down 10 percent from "normal levels", however, the increasing number of sales to international buyers in recent months is contributing to the upside in the market.  Interestingly, 24 percent of international buyers hail from Canada and 11 percent are from China.  As you can see on this graph, the number of foreclosures (in blue) and the inventory of unsold homes (in red) are dropping with the inventory hitting decade-low values:


Canada's housing market, thus far, has been one of the world's exceptional performers.  Sales in October dropped 10 percent from levels in the spring of 2012 but are roughly at the level seen during much of the past decade.  That said, things are far different depending your location in Canada as shown on this graph:


Home sales in both Alberta and Saskatchewan strengthened by 10 percent or more this year.  This is in sharp contrast to British Columbia, home of Vancouver's real estate bubble, which has seen sales drop by 10 percent.  Most other provinces have seen the volume of sales rise by between 2 and 7 percent.

Here is a graph showing the number of existing home sales (in red) and the average price (in blue) for all of Canada since 1990:


Here is a bar graph showing the composition of new builds:


Notice that row and apartment (i.e. condominium) dwellings are making up a record portion of total new homes built in the last three years.  This "new reality" can readily be seen in both Toronto and Vancouver where massive numbers of condominium projects have been brought on-line in the last three years.

Average prices in Canadian markets for both 2012 and 2007 and the total five year percentage price increases are as follows:

Canada - $364,389 (2012)  $307,089 (2007)  18.6%
Vancouver - $734,346 (2012)  $570,795 (2007)  28.8%
Calgary - $408,438 (2012)  $414,066 (2007)  -1.4%
Toronto - $499,249 (2012)  $377,029 (2007)  32.4%
Montreal - $316,554 (2012)  $250,213 (2007)  26.4%
Halifax - $270,501 (2012)  $216,339 (2007)  25%

Since we've all been hearing about Canada's over-enthusiastic and worrying consumer debt accumulation, here is a graph showing the percentage of Canada's residential mortgages that are in arrears by three or more months:


While less than one percent of Canada's mortgage-holders are behind three months or more, this is what it happened to foreclosures and delinquencies when the housing market in the United States imploded:


The number of prime mortgage holders defaulting rose to 7 percent by early 2009 as housing prices in the United States began to plummet.

What is saving Canada's consumers today is Mark Carney's program of ultra-low interest rates.  In the early 1990s, despite lower housing prices, household mortgage debt consumed between 6 and 7 percent of household disposable income.  Over the following two decades, this has dropped to the four percent level, a generational low thanks to low interest rates offsetting rising prices.

Looking at mortgage rates over just the past ten years alone, we can see that the current interest rate situation is anomalous:


When all of the data presented in this posting is considered, it is apparent that Canada's real estate market is an unsustainable anomaly, particularly when one looks at what happened just to the south of us as delinquency rates rose exponentially.  The situation could be just as bad in Canada when the problem of over-indebted consumers meets an environment of rising interest rates.


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