The CMHC used a stress test or worst case scenario to test what would happen in the Canadian Housing market if there were a quite significant downturn in the Canadian market. The CMHC projected a 30 percent plunge in home prices and a 5 percent increase in unemployment. This is what happened in the U.S. in 2008 when its housing market imploded. In such a scenario the CMHC would be faced with eight times more insurance claims than now, with total claims of $5 billion over five years. The CMHC profit of $7.5 would swing to a $2.8 billion loss.
Many analysts think the CMHC scenario based on what happened in the U.S. is quite unlikely to happen here. Sal Guaterei, an economist at the Bank of Montreal (BMO), notes in the U.S. there was a huge problem with sub-prime borrowers, a situation that does not really exist in Canada. While Vancouver and Toronto would be vulnerable if there were sharply rising interest rates and rising unemployment, even this would require a considerable shock to the economy that seems not likely to happen.
The CMHC notes if there were global economic deflation for five years, this could hurt the market. Oil prices being very low, for example $35 a barrel, for a similar period would also rock the housing market. Many analysts are concerned about global deflation, with bond investor Bill Gross noting the global economy is approaching deflationary growth. The IMF has voiced a similar concern. While oil prices are projected to stay relatively low for some time, most analysts do not see them going as low as $35 a barrel for any length of time.
With deflation, house prices could fall, and people would lose money on their investment in their house if they sell. At the same time, if buyers think that prices will fall further they will not purchase homes new or otherwise, so that there will be less investment in new housing and falling house sales.
As well as the CMHC, the Canadian Centre for Policy Alternatives(CCPA) and the OECD have also issued warnings about the Canadian housing market, especially if there is a short-term downturn in housing prices. The present heated housing market is partly caused by the baby boom bulge that created a big demand. Things are now changing.
Ben Rabidoux, of North Cove Advisors, a research firm says: “One of the more concerning developments that no one’s talking about is the demographic trend. We are adding the fewest number of people to the working age population that we ever have.”
The Bank of International Settlements notes that in an economy where more people are leaving the workforce than entering, as is starting to happen here in Canada, the economy as a whole begins to shrink and house prices are lowered as well, as older home owners put houses on the market. This trend happens when home owners reach between 60 and 70 years. The baby boomers are now beginning to enter that age range. In Alberta those older homer owners are often taking their homes off the market because they are not getting the prices that they want but others, because of their economic situation, may be forced to accept those prices. Builders of new houses will need to sell their houses to pay their expenses often at prices that yield little or no profit.
Rabidoux though does not predict possible doom for markets such as Toronto. Some housing will still attract good prices but others may not. He says some expensive homes built in rural areas are not likely to sell well but family-sized homes in popular city areas will attract those who can afford family homes since there is always a limited supply of these homes. As the boomers move out of homes the demand for larger condos in prime areas will remain strong. Rabidoux cautions however that his predictions have been wrong before.
The Canadian Centre for Policy Alternatives(CCPA) worries about the debt loads that high house prices place disproportionately on young people. The OECD has issued a warning specifically about the risk of a correction in Toronto which has seen a huge increase in condo development. The OECD pointed out that there are high debt-to-income levels in Canada and urged tightening of mortgage lending in overheated markets such as Toronto and Vancouver. The OECD said: “In Ontario, and especially Toronto, economic activity has been relatively buoyant and demand by foreigners has been boosted by the falling Canadian dollar. That said, newly completed but unoccupied housing units have soared in Toronto, increasing the risk of a sharp market correction.”
The Bank of Canada estimates that Canadian house prices are 10 to 30 percent overvalued at present.
Sharply falling prices could badly hurt younger home owners says economist, David Macdonald, of the CCPA: “Declines in real estate prices would have a strongly disproportional impact on young home owners, If, or more likely when, real estate prices fall, families in their 20s and 30s can expect to lose a substantial portion of their net worth, and could find themselves owing more than their house and other assets are worth.”
He points out that the debt-to-income ratio for people in their thirties is now at a new high of 4 to 1 about double what it was in 1999. This is a higher ratio than in any other age group.
Macdonald offered some numbers to back his views. Even if the housing correction is in the mid-range of what the Bank of Canada has projected that families with people in their thirties would lose on average $60,000 or close to 40 percent of their net worth. One in ten families with people in their thirties or younger would end up with negative net worth. Macdonald concludes: “In cities with higher prices, like Toronto, Vancouver and Calgary, young families would likely see declines in net worth dramatically worse than the national average due to higher leverage, A badly managed downturn in real estate prices could wipe out the wealth of a large number of Gen-Xers and Gen-Yers. We need to recognize that young families are the most likely group to be plunged underwater by a nasty housing correction.”
Foreign investment can also have significant effects on Canadian housing markets especially in Vancouver and also Toronto as discussed on the appended video.
