The Major Headwinds Facing Canada's Real Estate Market Part 1

This post is the 1st of a 3 part series on the major headwinds facing Canada's real estate market going forward.  There just too many to condense this into 1 post.

Household Debt
Is it me or does it seem that almost everyday there is a warning, study or report on how bad Canadian households finances are?  Last week Mark Carney warned again on household debt,  this week Stats Can is out with a report that debt to income has now reached 147.3% with their calculations, the highest ever, with debt still outpacing wage growth some are asking "Will Mark Carney ask for Credit Curbs?"

In fact, Canadian debt ratios are now “leaving their U.S. counterparts in the rear-view mirror, despite the repeated exhortations by domestic policymakers to rein in borrowing,” said Douglas Porter, deputy chief economist at BMO Nesbitt Burns.
“The prolonged period of ultra-low interest rates runs the risk of pumping a debt or housing bubble,” Mr. Porter said.

While debt to income looks bad, it does not look as bad as the US and UK had at their peak, meaning that there could be room for more growth. But... from Ben at the Economic Analyst

However, Stats Canada typically reports debt to personal disposable income while the US Federal Reserve typically reports debt to income.  Since taxation laws are quite different between Canada and the US, it is sometimes helpful to look at debt to disposable income of both countries.  Gluskin Sheff and Capital Economics have both examined debt using this measure.  This gives an entirely different perspective:

Just for reference, total household debt in 2000 was 600 Billion. 11 years later it is over 1.5 Trillion.  This is an increase of 150%. Notice how household debt skyrocketed with CMHC removing the price ceiling.

 While mortgage credit growth and consumer credit growth hit double digits year over year at the peak,in 2011 it has "slowed" to 7% and 4% respectively. 

Over the last 15 years mortgage credit growth has advanced 7.5% while the average wage has increased 2.3%. And if we take a look at personal lines of credit, they have exploded since 2000. In 2000, lines of credit for Canadians totaled just over 25 Billion.  That was the total balance.  In the last 3 years, Canadians have borrowed over 40 Billion in each year from lines of credit.  How is that for a credit party?

Household debt is by itself is enough to derail the housing market, but while household debt might be the biggest headwind facing the real estate market it is not the only one.

Worldwide Economic Malaise 
Europe
Europe is teetering on the brink of financial disaster.  Greece is on life support while the rest of the PIIGS are not that far behind.  It has been bailout after bailout.  If Greece goes bankrupt, there could be a domino effect with those countries, essentially putting those countries financially back by decades. But are bailouts just prolonging the agony?  The debt needs to be paid eventually. Wait and see I guess.  Europe is definitely the Number 1 area to watch for Worldwide economic trouble.

Japan, once the brightest economy in world in the 80's had their asset bubble popped and they have never recovered.

Their growth in the last 20 years has been anemic and with a debt to GDP the highest in the world at 225%, the oldest population in the G7 and the recent tsunami do not help growth in the future.  Japan is among the top importers of Canadian resources, but this figures to slow in the future.

China
China can only build so many vacant skyscrapers, roads and bridges to nowhere, vacant malls and cities for so long.

From Mish
Eight Problems Facing China
Hot money inflows
Huge property bubble
Massive increases in money supply, much of it property speculation and building of unneeded capacity
Currency manipulation charges from the US and potential trade wars
Unsterilized trade imbalances fuel inflation
Slowing Europe
Dearth of Jobs for new graduates
Potential social unrest

A slow down in China is pretty well guaranteed, it is gauging whether or not it turns into a hard landing is the big question. But China hard landing bets are rising as it now costs more to bet on Renminbi strength than weakness.

it now costs more to bet on RMB weakness than strength. It adds: "China appears headed for a hard landing as the country’s housing market shows more signs of weakness. Currency traders have reduced their expectations for more appreciation of the yuan versus the dollar in the derivatives market, meaning they expect Chinese policy makers to fundamentally shift their approach to the currency due to economic softening. Other markets may soon follow currency’s lead."

China's Ghost Cities 
TD Bank: Hard Landing in China would deal significant blow to Canada

Middle East
The Middle East is basically a powder keg at the moment.  Economic uncertainty at its finest with Governments getting over thrown and protests happening daily in this region.  Adding 3 wars in this oil rich area makes this an area we should not overlooking because we are focused on problems in Europe.

US
Do I even need to talk about the US?  Housing peaked in 2005 and the subsequent crash in that and funny business almost derailed the world economy.  The Feds have thrown everything they have at the problems and it is not enough.  It might be a generation before the US really recovers, if it ever does.  Right now the biggest problem in the open is raising the debt ceiling so they can continue borrowing money.  But questions are being raised about how much derivatives exposure American Banks have to Greece and other PIIGS countries.

Australia
Australia, like Canada is country that has resources and also did not have their housing market crash in 2008.  Any losses sustained in 2008 were quickly erased when the Government encouraged borrowing and gave tax credits to new homeowners.  Now housing is at record highs, but so are debt loads.
But the shine of the housing market is starting to fade.  With a slowdown in Asia, a housing bust in Australia is certain.


More on the Australia housing bubble

Why Australia is Set to Follow US Path of House Price Doom
RBA warns many first home owners who used grants may now be vulnerable
Arrears on mortgage repayments spike to record highs 
Home loans drop to ten year low
Home prices down in most major centers

While there are other areas in the world like Russia, India, South America that could come out of nowhere and cause economic problems, the biggest areas of concern for Canada is Europe, China and the US at the moment.  The next decade will be nothing like the last.  With so much debt and bloated Government balance sheets, we could definitely see some significant countries go bankrupt.   This would send commodities into a tailspin.  And with that, the possibility of a second credit crisis.  World wide economic malaise is a serious headwind for Canadian real estate.

Conclusion to Part1

My take is that household debt will cause for what Garth says " a slow melt" for Canadian house prices over the next decade at least, with many places experiencing a "jolt" at the beginning of the bust.   What I have found throughout history is that it usually takes a real estate market a generation to recovery from the bust, I see no other reason why this would change for Canada.

Worldwide economic trouble such as countries defaulting and/or second credit crisis would be like taking that ice cube and throwing it into the microwave. A "fast melt" back to long term fundamentals, maybe an overshoot.  But if by a small chance no countries default ( hard or soft) a "soft melt" is probably what will happen.

Make no mistake these two headwinds are very strong and for people to overextend themselves with real estate today in hopes for capital appreciation tomorrow is foolish.