Canada's Fragile Housing Market?

David Kitai of Mortgage Broker News reports on a report that says the Canadian housing market is due for a crash:
A report from an international macroeconomic research firm says that Canada’s economy is headed for a long, difficult period due largely to the effects of COVID-19 and the weaknesses in Canada’s housing market.

The report “Canada on thin ice as it heats up” by Macro Research Board (MRB) partners paints a bleak picture. The report says that Canada has followed global trends in falling into a ‘sudden stop’ recession with high unemployment and a plunge in activity. It says that Canada is more exposed than most economies, however, because of “an unstable real estate bubble and household credit binge.” It says policymakers are putting off the day of reckoning but have run out of ammunition and there is no guarantee they can prevent a housing bust. The report says such a correction will have long-term positive effects in creating more caution among Canadian consumers, the short to medium term will be a rocky road to recovery.

“The Canadian economy has been increasingly driven over the past decade by the real estate boom and debt-fueled consumption binge,” The report reads. “In turn, a substantial housing and credit bubble has developed on the back of overly accommodative policy. We previously identified Canada as a candidate for a future housing downturn and deleveraging cycle but had noted that there was a lack of a sufficient adverse catalyst to bring these imbalances home to roost. That all changed this year. The heightened uncertainty caused by the surge in unemployment and plunge in household confidence may encourage many Canadians to reconsider stretching beyond their means heading forward.”

While the report notes that the Canadian government is aggressively attempting to prevent a major deleveraging cycle, if it does develop it may prove to difficult and costly to stop. They say most indices they’re watching, such as upticks in shopping or downturns in the amount of time Canadians are spending at home, don’t point to a surging restart in the Canadian economy.

Unemployment surging is, according to MRB partners, a “massive headwind” for Canada’s housing market. While low rates and stimulus are helpful, if job losses prove sticky during the reopening there’s a risk of a crash in the market. MRB’s analysts say Canada needs a V-shaped recovery to avoid such a crash.

Underlying this issue, according to the report, is a decade of surging property values and a deterioration in household balance sheets, with many Canadians now living in massive levels of consumer debt. Despite aggressive support policy, MRB says the housing bubble they see is set to burst, though they are closely watching activity as restrictions on viewings ease.

The report doesn’t make a regional breakdown of Canadian housing numbers, but does raise the concern that supply was already beginning out outpace demand before the pandemic. Unsold inventories have been surging over the past two years, at levels close to housing crash of the early 90s. As builders get back to work earlier than much of the general economy, the record levels of construction in cities like Toronto pose a risk of glutting the market.

MRB’s report says that emergency measures like CERB, the wage subsidy, and the deferral of mortgages, all risk compounding the problem. If they’re allowed to run out at a certain time and the economy fails to make a rapid and stark restart, MRB is highly concerned about the possibility of a “deferral cliff.”

“Extreme fiscal policy efforts are providing temporary support but it will prove difficult for Canadian policymakers to prevent a material housing fallout, unless the domestic (and global) economy experience a V-shaped recovery and soon restore employment to pre-shutdown levels (which we are not expecting),” the report reads. “Substantial oversupply and the lack of valuation support are major problems at a point when the housing market faces new and powerful headwinds. When homeowners are stretching to buy, they need to believe that their jobs are secured (and wages will increase) and that their home value will continue to appreciate. If these conditions are threatened (which is now the case), it can quickly weaken confidence and housing demand, causing prices to fall substantially. This was last seen in the U.S. and parts of Europe during the late-2000s. Canada is now at the cusp of heading down this path if employment and job security do not rebound strongly and shortly.”
Feel free to contact MRB Partners here to get a copy of this report.

It's not just MRB Partners. Earlier this month, the National Bank of Canada joined the Canada Mortgage and Housing Corporation (CMHC) to forecast the sharpest real estate price decline ever:
One of Canada’s Big Six banks is joining the CMHC and credit risk agencies in forecasting lower prices. National Bank of Canada (NBC) economists expect real estate prices to make a sharp drop this year. The bank is calling what would be the largest price drop in Canada’s history, with Toronto and Vancouver hit hardest.

Canadian Real Estate To Get Biggest Recession Price Drop In Years

The bank’s forecasting the largest recession drop for real estate prices in Canada’s history. Prices are forecasted to fall an average of 9.8% from 2020-2021. To contrast, prices dropped just 6.3% during the 2008 recession. During the 1981 recession, the largest home price correction to date, prices dropped 9.2%. This is on the low end of Canada’s national housing agency’s forecast, and below most risk agencies.

The forecast does model region variances, with the largest drops in expensive cities. Toronto real estate prices are forecasted to dip 13% from the end of the year through next year. Vancouver real estate prices are forecasted to fall 12% over the same period. Montreal, which only started to climb quickly recently, is expected to see a 7% price decline. Montreal’s price gains lagged national gains, so a smaller impact wouldn’t be a surprise.

Unemployment Is Rising, and Immigration Is Expected To Fall

The biggest contribution to this trend is expected to be unemployment. The bank sees retail, accommodation and restaurants, and the arts impacted longer. They also see unemployment averaging out at 9% by year end. This is lower than most other bank forecasts, but still high enough for a recessionary environment by itself. They expect this to have a big impact on immigration.

The hit to employment is expected to have some fall out when it comes to immigration over the next few years. Canada doesn’t have a plan to lower immigration. In fact, the government plans to stick to its population growth strategy, which would see mild increases. Despite this, the bank’s economists note during recessionary periods, immigration voluntarily declines. This trend is observed in all three previous recessions, and expected to occur in this one.

Low Interest Rates Not Expected To Have The Same Impact

During past recessions, lowering interest rates helped to stabilize real estate markets. This is expected to have a smaller impact this time, since rates were already very low to begin with. The bank notes 5-year mortgage rates only declined 17 bps from the beginning of the pandemic, to now. To contrast, the overnight rate has shed 150 bps over the same period. When home prices are at record highs, and mortgage rates at record lows – lenders now face a high risk and low reward prospect.

NBC’s forecast is mostly in line with Canada’s other Big Six banks, which see declines in this range. CIBC notably stated they expect Toronto and Vancouver to see bigger price corrections than the rest of the country. The big banks, credit agencies, and national housing agencies all have similar timelines though – with significant price declines not showing until the second half of the year.
So, is the great Canadian housing crash finally upon us? I've been bearish on the Canadian housing market forever and my biggest fear was a global deflationary crisis where even though rates are at record low levels, unemployment soars making it impossible for over-indebted Canadian households to meet their mortgage obligations.

The COVID-19 pandemic has brought about this global deflationary crisis and it won't only hurt the Canadian housing market:

And here's the thing, if housing gets hit in Canada and the US, banks are in big trouble and stocks will get hit hard.

It's what CalPERS' CIO Ben Meng called the "tertiary effects" of this healthcare crisis when we spoke last week.

Of course, there may be a V-shaped economic recovery in the US and Canada but judging the way things are going when economies reopen, I wouldn't bet on it:

But stocks keep going higher led by the Nasdaq, isn't that bullish?

Ah yes, stocks, especially tech stocks are what all these V-shaped recovery people hang their arguments on, completely oblivious to reality.

As I keep telling you, stocks are enjoying their last liquidity orgy no thanks to Uncle Fed's $3 trillion QE injection, but Operation Warp Speed is hitting a roadblock so I wouldn't get excited about stocks or read too much into them as a leading economic indicator because it's all liquidity nonsense.

If you don't believe me, listen to Chris Ailman, CalSTRS' CIO, who thinks the market is "absurd":

Of course it is but this is what happens when a bunch of large CTAs and quant funds front-run the Fed and keep buying tech shares on every dip as long as they remain above their 10-week moving average:

It's a classic momentum market in Tech Land and it will end badly and burn a lot of investors but right now, the Fed, CTAs and quant funds are trying to make the pain trade a lot more painful by bidding up tech shares.

Still, don't confuse the Nasdaq with the housing market, stocks are being driven higher by liquidity but the Fed and big banks are petrified of a commercial and residential real estate crash.

The Canadian housing market is even more vulnerable but if you talk to homeowners and real estate agents, they're delusional, thinking the "Chinese will keep buying more" as supply hits the market.

I've been hearing the same dumb arguments for years but in the end, real estate is a function of two factors: unemployment and rates. And no matter how low rates are, if unemployment is soaring the market will crater.

A buddy of mine in Toronto sent me this website which shows you condos for sale and rent. He said this: "The building is 4 years old with 67 floors and 1343 units. There are 46 for sale and 149 for rent. The average rent price is down 8.88% so far when compared to last year".

All these Toronto condo flippers buying condos with the bare minimum down and hoping to rent them using Airbnb are in huge trouble and I can't say I'm surprised, it was a disaster in the making.

What happens if the Canadian housing market craters? You don't want to know but let's just say the loonie will drop like a stone, especially if housing and oil get hit concurrently:

I'm short the loonie and expect it to go under 70 cents US and even make a new low below 68 cents if things get really bad over the next year, meaning a housing crash.

On that cheery note, enjoy Canada Day, but before you do, I also want you to read two articles:
I'm ashamed of how poorly Canada has done relative to other OECD countries in terms of COVID deaths at our long-term care facilities.

Politicians will point the finger at each other but it's high time we focus on fixing this national travesty.

What else irks me about Canada? We love talking about how open, diverse and inclusive we are but recent events demonstrate how we have yet to address systemic racism in this country.

We also need to illuminate the disability job gap in this country and make a real effort to listen to people with disabilities and embrace a ‘new, improved and accessible normal’ in a post-COVID-19 world:

So, as we all celebrate Canada Day for the country we love, just remember that loving your country also means critically examining it and coming up with solutions to make it a better, safer, more diverse and more inclusive place for all our citizens.

Also, we are still in a pandemic, so remember to wear your mask if you're in a crowded public place, wash your hands often, respect social distancing and take at least 1,000 IUs of vitamin D a day (never mind the skeptics, I have over 20 years of experience taking vitamin D to prove them all wrong!).

Below, the trailer for Netflix's hit show Queer Eye. My wife and I have been binge watching it lately and we absolutely love it, great show, really well done and shows you that tolerance, respect and empathy are the foundations of an open and diverse society.

Have a safe, lovely and beautiful Canada Day and don't worry, this too shall pass one day.