There's so much negative information out there, we thought it was time to sort it all out for you. Does anyone know the future? Absolutely not. But it's important to sort out facts from opinion, and carefully eliminate the knee-jerk panic reactions. Experience shows that decisions based on fear generally don't turn out very well.
Most economists have agreed that the risks of the same fate in Canada are much lower because of some important differences. From nearly twenty recent reports and over 100 pages of stats, we've tried to summarize them here for you...
Canada's subprime market is small (5-6 per cent of outstanding mortgages) whereas the U.S. share peaked at about three times that. As a share of originations, 20-25 per cent of new mortgages in the U.S. were subprime over the 2004-06 period. So Canada isn't anywhere near as exposed to the products that caused most of the damage in U.S. housing markets. Not only is Canada's subprime market much smaller, but it isn't even really subprime per se. Canada's subprime market is more like the U.S. near-prime market, whereas the U.S. subprime market often lent to borrowers with extremely impaired quality. We affectionately call these types of loans "Ninja" - the no-income-no-job-no-asset mortgage!
Adjustable rate mortgage (ARMs) resets also caused many of the problems stateside, but those resets occur much more suddenly in the U.S. By contrast, the closest Canadian product parallel is the variable rate mortgage, but they get constantly repriced so that people aren't caught offguard years later. Furthermore, in Canada, some variable rate products adjust the principal, not the payment. On balance, the shock effect from payment resets in Canada is nowhere close to what has caused much of the problem in the U.S. Many homeowners in the U.S. experienced a doubling of their payments almost instantaneously, with very little warning!
Mortgage interest is deductible against taxes in the U.S. It generally is not in Canada. That creates vastly different incentives to leverage oneself in the two markets.
The extent of runaway house price inflation was much more muted in Canada than in many other countries. Canada's priciest market is Vancouver, and prices have gone up by about 80 per cent since the mid-1990s start of the global housing cycle. London, England, by contrast, went up by about 270 per cent over this time period. Canada's house price appreciation was, on average, significantly below the U.S. experience since then, and much below the experience of many European countries.
Unlike many U.S. banks, Canadian banks continue to apply prudent underwriting standards. In other words, they have always checked, and continue to check, incomes, verify job status, ask for sales contracts, etc., such that all those questions your banker asks in Canada have a purpose that somehow got lost on many American bankers. Plus, most Canadian mortgages remain on the lenders' books, and there is strong incentive to maintain high credit standards. Only about 6% of Canadian mortgages are held by special purpose corporations and non-depositary intermediaries. In the U.S., on the other hand, widespread securitization eventually caused a breakdown in the incentive to control risk. When it became apparent that mortgage originators would not have ultimate accountability for credit quality, credit quality was abandoned. When there's no accountability, it's not long before things fall apart.
During this decade, the Canadian economy has been much stronger than the U.S. economy. The U.S. economy peaked at the start of the decade. While it recovered somewhat during 2005 and 2006, the ratio has remained well below the prior peak. By contrast, the Canadian economy has shown increasing strength in this decade, and the employment-to-population ratio has set new record highs every year from 2003 to 2008. Moreover, to the extent that the U.S. economy did improve at mid-decade, most of the growth was from the housing market - increased construction plus home equity take-out. There was a self-reinforcing bubble in the housing market. In Canada, on the other hand, economic growth has been diversified and much more durable. The Canadian economy has done a very good job of generating highly-qualified home buyers; in the U.S., slower job creation has meant that there have been fewer good mortgage candidates. Credit quality has remained very strong in Canada but slipped badly in the U.S.
Canadians have retained strong equity positions in their homes. Scotiabank estimates that in Canada, home equity is equal to almost 70% of the values of residential property - in other words, total mortgage debt is only about 30% of the total value of Canadian homes, and the equity position today (almost 70%) is stronger than it was a decade ago (about 66%). In the US, on the other hand, there has been sharp erosion of home equity, which began during 2001/02. By 2004 - well before the onset of the current US troubles - the equity position had already seriously eroded.
There's no doubt... our current market is in a state of flux. There's widespread speculation about what will happen, and you can choose to believe what you like.
Recently, in the Greater Toronto Area and Burlington, the trend we're seeing is about 20% more homes on the market compared to one year ago, however the number of sales has remained quite similar, or decreased slightly, depending on the neighbourhood. On the surface, most people read this and believe that supply is elevated, demand is equal or lower, so prices must be suffering.
So far, this has not necessarily been true. We believe the reason is that two different markets have developed. On one side, we have the "sellers" - these are people who have kept their homes well, live in good locations and are generally desirable places to live. The "sellers" have priced their homes reasonably, and as a result, they have been selling the same, or for even more money, than in previous years (although it sometimes takes a little longer to sell). On the other hand are all the "listings". These are the homes that have something undesirable - either the condition of the home, the location, or the price. Even a small thing can completely dismantle the chances of these homes selling. As a result, these homes are staying on the market, lowering prices, and creating a logjam of inventory that is having a negative effect on prices of these "listings". Plus, buyers are getting pickier, and there aren't as many buyers out there with the constant onslaught of media attention on bad news in all markets.
When it comes time to sell, will you be a listing, or a seller?
The "C" homes did just fine in the "A" market, but now that we're in a "C" market, you need to be an "A" type of home. Same goes for real estate agents... you could hire the "C" player a few years ago, but now, more than ever, you need the top-notch "A"-level real estate agent to make things happen and sell with the best result.
If you can catch it at just the right time, the current market may provide a small window of tremendous opportunity. To take full advantage of this fascinating market, my recommendation would be to give me a call at (905) 681-7900 so we can review what's important to you, and give you the best information to keep your family safe and build your wealth. If we can't help you, or if we know it's not the right time for you, we promise to let you know immediately.
Lee Plouffe
P.S. You can also reach me with comments or questions at lee@stargroup.ca
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