Is Canada Having a Housing Bubble? And is It Popping?

Canada's housing prices have been rising briskly--until now. What the correction might tell us.

One of the enduring mysteries of the financial crisis was how Canada managed to avoid it. There have been various arguments about the structure of its banking system, but I didn't find many of them convincing; they all seemed to basically be lists of ways that the Canadian banking system differs from America's. And it does differ, in significant ways, but the analysis was far too US centric. Many of the features cited as its crisis prevention are shared by systems in other countries that did have housing bubbles and banking crisis crises. It's not as if Canada had discovered some amazing new way of regulating banks; its methods were at best different in degree, not in kind.

So the mystery remains: why no bubble in Canada? Why no banking crisis? My best working theory was that their banking system was run by Canadians, who are a very sensible people. Yes, I admit that this theory is a little hard to test, but I can offer some supporting evidence: they also sat out the Great Depression, and the Panic of 1907.

Over the last year or so, however, another possibility has been emerging: they didn't avoid the crisis. They're just getting it on tape delay.

A slight digression: those of you who watch HGTV may have noticed a lot of Canadian accents on the shows. As I understand it, that's because HGTV's Canadian operation must have a lot of local shows; by law, about half of all television programming must be "Canadian content", filmed or otherwise created in Canada. Since Americans don't care, you might as well film the stuff in Canada and air it in the US. When you see shows studiously avoid mentioning where they take place--an odd choice for a real estate network--it's a pretty safe bet that they're happening somewhere in Canada.

Over the last few years, this has offered an interesting insight into the Canadian housing market. To whit: it's gotten hella expensive. I live in one of the most expensive urban housing markets in the nation, and the prices that these couples will pay for tiny, undistinguished row homes in outlying areas are often enough to make my eyes pop. It's like watching a rerun of 2002-2006 in America. The young couples buy brand-new construction with ample square footage and sleek fixtures, while an astonishingly high percentage of the families are shopping in the mid-to-high six figures. Every renovation generates more than enough home equity to cover the cost, because prices go nowhere but up.

In the major Canadian population centers, the price-to-rent ratios had reached alarming levels by the end of 2011. For reference: a price-to-rent ratio of about 15 means that it costs about the same to rent as to buy. Lower than that, and you should buy, because you're getting a deal. Higher than that, and buying will probably cost you more.

It's hard to see why prices should be so high. The average sale price of a Canadian home is about $350,000--75% higher than in America. To be sure, Canada is a rich country, on a per-capita basis, and its population tends to be clustered along the border. Nonetheless. America's hottest real estate markets are propped up by global capital and a handful of very-high-margin businesses (finance in New York, Hollywood in LA, tech in the Bay). They're augmented by globetrotters who want second and third homes in world-class cities. While I understand that there is some of this on Canada's west coast, the country is an almost aggressively middle class place with some rather disheartening weather. This will always limit the global appeal of its real estate, and it's hard for me to imagine that foreigners are massively bidding up the market for 1920s semi-detached homes in Toronto suburbs.

The Canadian media have started asking the same questions. People are now openly arguing over whether there's a bubble, though that argument hasn't attracted much notice on this side of the border. Last summer, the finance minister put new mortgage rules into place in an attempt to engineer a slowdown. Sure enough, house prices are falling:

Canada's housing market continues to cool markedly, with sales plunging 17.4 per cent in December from a year earlier. Prices, however, still held up, with a gain of 1.6 per cent from December, 2011.

On a month-over-month basis, sales were little changed from November, the Canadian Real Estate Association said today. New listings slipped 1.3 per cent from November as home sellers pulled back.

For 2012 as a whole, sales of 452,372 slipped 1.1 per cent from a year earlier, and were 1.4 per cent below a 10-year average to 2011.

Sales in December fell in four of every five housing markets measured, the real estate group said, with Calgary the standout exception.

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But many observers expect the setback to be temporary. As long as interest rates are low, they say, Canadians will continue to load up on debt, and the things that get bought with debt.

How this shakes out will matter a lot. It will tell us a lot about the causes of housing bubbles: are they rooted in poor bank regulation, or other fundamentals? And also about how much bank regulation can do to stop them. If the tighter rules do engineer a soft landing, that's evidence that prudent bank regulators can prevent crises. If, on the other hand, Canada gets its own housing crash, and banking woes, despite the finance minister's best efforts, that will suggest that there are real limits to how much even the most prudent regulator can accomplish.