During the depth of the financial crisis, the political appetite to rein in perceived excesses in various segments of the economy was significant. It seemed that international conferences amongst the G20 nations were being held at ever shrinking intervals promising that those deemed to be held responsible for the financial fraud would be held accountable and new regulations were sure to be implemented. The implicit message from the business community and the politicians was that lessons were learned and the same mistakes would not be repeated.
One of the most surprising things has been despite all of the upheaval, how little has changed with respect to real estate prices. From Beijing to London, real estate prices have climbed back faster than would have appeared possible only a couple of years ago. While attending the annual market forecast dinner for the local CFA society, one of the speakers on the podium asked the attendees: “Has Canada learned nothing from the United States?” This was in response to the discussion about expectations for Canadian interest rates and the incredible rebound in Canadian real estate prices.
The reason this question is so relevant is that internationally, it is thought that Canadian real estate does not suffer from the broad levels of excess that has been seen in other parts of the world. However, it is not a question of excess on the Canadian level – rather, what is happening at the regional level and just how much debt are Canadians taking on.
It would seem plain to see that the Canadian banks and the government are getting a little skittish as well. While they are careful to claim there is no Canadian real estate bubble, it might come down to a question of semantics. In the US, it can be argued that there was not an American real estate bubble – just one in Nevada, California and Florida. In Canada, it could be claimed that the bubble is only in Vancouver and the other major metropolitan centers. What we have seen is that when a large market hits turbulence, the impact is felt much further than just the epicentre of the boom.
In Canada, a significant amount of fiscal and monetary resources were committed to ensuring that the real estate market was stabilized. This helped to encourage Canadians to take on record amounts of debt and take advantage of the brief pull back in real estate prices. However, nobody seems to be asking the question “What happens if interest rates go back to normal levels?”
We are finding out that answer now as we have seen mortgage rates rise more than once within the last month alone. In addition, the federal government has begun to respond to the concerns of the banks to issue tighter guidelines for mortgage underwriting.
Some observers are now coming to the conclusion that policy makers wasted the opportunity to guide the global economy away from the debt-consumption cycle. Amazingly, the US seems to be leading the world in bringing down debt and increasing savings because consumers there felt the impact of too much debt and not enough saving more than in most nations.
As has been mentioned before in previous posts, a surprising number of Canadians assume that they are not as reckless as Americans when it comes to piling on debt. The numbers seem to be showing otherwise. Part of the reason for this debt is that incomes in Canada have been stagnating relative to rising mortgage and credit card debt.
Some of the best work produced in a long while with respect to looking at real estate prices in Canada comes from Alexandre Pestov published at the Schulich School of Business. Petrov’s analysis led him to conclude that the affordability levels in major Canadian cities – led by Vancouver – are worse than in the twenty largest metropolitan areas in the US during their boom.
(Click on chart to enlarge – Courtesy: Alexandre Pestov – Schulich School of Business )
In Vancouver, there seems to be a prevailing logic that “Vancouver is unique therefore prices are justified?” People in Miami or San Diego probably felt the same way a few years ago.
What makes a city unique is income, employment prospects and livability. At the elevated valuations we are seeing currently, it would appear that for prices to continue higher, Canadian real estate prices – led by Vancouver – will have to demonstrate the “Greater Fool Theory” – where sky high prices fueled by record amounts of debt can only continue if there is someone else willing to take on even more debt and pay even higher prices. This sounds like a recipe for trouble.
As James Chanos, the renowned hedge fund manager who is shorting Chinese stocks – said in a recent television interview – it is not high prices that mark the existence of a bubble but rather high levels of debt punctuated with a lack of rational behavior. In his words, China is “on the treadmill to hell”.
Likewise, for Vancouver or other Canadian cities, it cannot be said that there is a real estate bubble just because prices have run up. That logic is linear and simplistic.That is too easy a hurdle to earn the bubble label. Rather, it is the herd mentality and the belief that somehow “this time is different.” Those four words are often said to be dangerous to one’s financial well being.
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