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The Canadian Housing Market

Canada is a nation of homeowners, for the most part, with just 30 percent of households being renters. House prices have been rising rapidly in recent years, which means a lot of these homeowners have seen the value of their homes rise, lifting their net worth. However, we also know something else has been happening that a lot of these homeowners probably haven’t noticed: Their rent has been going up. And up a lot!

Just because 70 percent of Canadians own their own home doesn’t mean 70 percent of Canadians don’t pay rent. What it does mean is that the vast majority of that 70 percent probably has no idea how much their rent has gone up in recent years, instead focusing on how much more their home is worth.

Everyone needs to live somewhere. Canadians still need to live in apartments, townhouses, semi-detached houses, and single-family homes. But Canadians don’t need to own.

However, more Canadians own their homes today than at any point in history — and this is true despite the fact that prices have risen considerably over the last few decades, to such a degree that many experts think Canada’s housing market is significantly overvalued. Why has home ownership been rising? Government programs encouraging home ownership are part of the answer. But I think a big reason for rising home ownership rates is that it has been a winning strategy. As I just noted, house prices have been rising sharply for a long time. And everyone who has owned has made out like a bandit! (Or so says the common wisdom.)

Source: Canadian Real Estate Association (CREA).

The good news is that Canadian homeowners have seen the value of their homes rise, creating significant wealth. The bad news is that house prices are high. If you haven’t heard, not only are Canada’s rising house prices seen as expensive by Canadians, but a good number of experts from around the world have voiced concern about our house prices.

 Robert Shiller, co-creator of the S&P/Case-Shiller U.S. National Home Price Index, Nobel laureate, and Yale economist, began calling for a correction in Canadian house prices in 2011.

 Goldman Sachs warned of an overheated Canadian housing market in 2013 and 2014.

Some of the others who have expressed concern about inflated prices in Canada’s housing market include the following:

 The International Monetary Fund (IMF) — 2013, 2014

 Paul Krugman, Nobel prize–winning economist, City University of New York economist (2013)

 Pimco, the world’s largest bond fund manager, with $1.4 trillion under management (2014)

 Deutsche Bank’s chief economist, Torsten Slok (2015)

 Fitch Ratings, the global credit ratings and research company (2014)

 The Organization for Economic Co-operation and Development (OECD) — 2013

 Bank of Canada — 2011, 2012, 2013, 2014, and 2015

 Canada Mortgage Housing Corporation (CMHC)

So what has gotten all of these global authorities worried about Canada’s house prices? Lots of concerning statistics and comparisons are being made to the U.S. housing market. Canadian house prices have risen at a pretty high rate over the past twenty years.

Source: CREA, U.S. Federal Housing Finance Agency.

House prices haven’t just been going up in absolute dollar terms, they’ve also been rising relative to incomes.

Source: CMHC, CREA.

House price increases have also outpaced growth in the cost of renting.

Source: CMHC, CREA.

At the same time, Canada’s per capita debt levels have risen to record highs, eclipsing the levels seen among American’s at the peak in 2007.

Source: Statistics Canada, Federal Reserve Board.

It’s hard to come to any other conclusion than that housing in Canada is quite expensive.

Perhaps the most disturbing thing about the above chart is that the interest payments Canadians now make on all of that debt don’t include the implicit rent the 70 percent of Canadians who own their own homes probably aren’t even aware they are paying.

Look at what these five charts we’ve just seen say: 1) House prices are at record highs in terms of dollar values; 2) House prices in Canada continued to rise significantly after U.S. house prices dropped nearly 20 percent across the country;

3) Canadian home prices are at record highs relative to income, having grown dramatically faster than incomes over the past decade and a half; 4) Canadian home prices are at record highs relative to rents, having grown dramatically faster than rents over the past decade and a half; 5) Canadians are carrying dramatically more household debt as a percentage of income than at any time in modern history. If you take an objective look at those statistics, it’s hard to come to any other conclusion than that housing in Canada is quite expensive. There are arguments on both sides of the debate of whether house prices will keep rising or whether they will fall. Whatever happens, whether house prices fall or whether they remain expensive, the prospects aren’t good if you’re thinking about buying a home (unless, of course, you wait for a really large correction before buying).

While it might sound a little counterintuitive, further increases to house prices in expensive cities like Vancouver and Toronto aren’t very good news for potential home buyers, as prices are already very expensive compared to historical levels. First-time homebuyers today are more saddled with debt than at any time in the past twenty-five years, leaving them committing to decades of payments with lesser prospects of higher prices in the future than earlier buyers.

Beyond all of the Canadians who might be considering buying a home, this situation isn’t good for Canada. The 70 percent of Canadians who own their homes have huge portions of their wealth tied up in expensive assets that might deliver modestly positive returns over the next several years, or they might deliver negative returns. Neither would be as good as a cheap housing market in which the majority of Canadians could spend less on housing, and expect better odds of increases in house prices to boost their net worth and provide a higher return on their largest asset.

The run-up in house prices had been looking a little more reasonable when U.S. house prices were rising alongside Canadian house prices in the early 2000s. At least we had company … until the U.S. housing market collapsed in 2006. The magnitude of that crash, and similarities between pricing levels and indebtedness in Canada today and the United States just prior to their housing crash, have many people questioning whether the gains in Canadian house prices can persist.

Low interest rates have played a significant part in rising house prices, allowing each dollar of interest paid to cover more and more mortgage debt. Interest rates have fallen dramatically over the past twenty and thirty years. Using the same monthly mortgage payment, today’s five-year fixed mortgage at 2.4 percent covers 72.5-percent more mortgage balance than the same payment covered as recently as the year 2000, when five-year mortgages were 8 percent. Not only that, but the total interest paid over the life of a twenty-five-year mortgage at today’s rates would be half the amount paid on an 8-percent mortgage despite the mortgage amount being 72.5 percent larger. If you think mortgage payments are scary now, ask someone who owned a home in the early 1980s how crazy mortgage payments were when interest rates were massively higher, reaching over 20 percent.

If you assume Canadians are buying houses based on how much monthly payment they can afford, the decline in interest rates could account for 72.5-percent higher house prices since 2000, compared to the actual ~200-percent increase in the average Canadian house price since then.

This is a point that is often used to argue for a pending Canadian housing crash. The worry is that if interest rates were to rise back up to an 8-percent five-year mortgage, house prices would have to decline to offset the increase that lower interest rates helped move higher, to maintain roughly similar mortgage payments, which in theory could result in a 42-percent decline in average house prices.

It seems pretty far-fetched for interest rates to rise to 8 percent in the near future, but you never know. Nevertheless, interest rates don’t need to go to 8 percent to hurt demand for home ownership.

As house prices have continued to rise, it’s not surprising that ownership rates have been rising. The positive impacts of a rising ownership rate and falling interest rates on house prices are pretty self-explanatory. It’s a positive feedback loop, with rising prices encouraging more people to “invest” in home ownership, resulting in more demand, which ultimately supports higher prices.

It’s also pretty easy to understand that if ownership rates were to stop rising or begin to fall, and if interest rates were to stop falling and even rise, house prices might start to fall.

What might be less easy to see is the unique physical structure of Canada’s housing markets and how that affects house prices. When it comes to the structure of Canada’s population, I find our country to be fascinating. I spend a good chunk of my time studying real estate markets, in Canada and around the world, looking at where population is concentrated, how cities are set up, and how those factors influence property prices. When I travel to other parts of the world to talk to real estate investors about Canadian real estate, one of my favourite things to do is tell investors who don’t know a lot about Canada how incredibly concentrated our population is. The responses can be priceless.

I’ve found that people who have never been here or don’t know much about the country usually do know three things. The first is that Canada is the second-largest country in the world by area. The second is that our population of 36 million people is pretty small.

With more than 9 million square kilometres of land, that works out to about 3.4 people per square kilometre. About 167 Canadian football fields fit into a square kilometre (CFL fields are 43-percent larger than NFL fields — just saying), which means Canadians have about forty-nine football fields of space each. That’s a lot of space for each of us to run around in.

Canada’s population starts to look very, very small when you compare it to the United States, which has a population of 332 million people. The United States is slightly smaller than Canada by area and has more than nine times as many people, leaving about thirty-five people per square kilometre. That’s less than five Canadian football fields for each American. Not cramped, but we still have ten times as much space each as of our friends south of the border.

Source: OECD Regions at a Glance.

But even the United States is pretty spread out when compared to other countries. India, at almost 1.3 billion people, has about thirty-five times the population of Canada and a land area of about one-third the size of Canada, with almost 390 people per square kilometre. That’s less than a half a football field each. With 160 million people, Bangladesh is tops among large countries, with almost seven people per football field.

It’s easy to see why outsiders looking in at Canada might think it’s a vast, barren land, one that is barely populated. Maybe they think all Canadians live solitary lives in cabins deep in the woods, rarely running into each other. After all, each of us has almost fifty football fields of space, while the average Bangladeshi shares a single field with six friends.

Which brings us to the third thing most people know about Canada: It gets cold. For a good chunk of the year. In fact, in winter Canada is one of the coldest places in the world — almost as cold as Russia, and not much warmer than Antarctica

Why does this matter? For all of Canada’s massive expanses of land, Canadians are living virtually on top of each other.

Canadians are overwhelmingly concentrated in just a few cities across the country.

Canadians are overwhelmingly concentrated in just a few cities across the country, with more than 80 percent of Canadians living within 160 kilometres of the U.S. border. Any further north, and it starts to get very cold.

All joking aside, the population centres are also concentrated along the border because a large portion of the border runs along the St. Lawrence River and the Great Lakes, which are important shipping and trade routes and were even more important over 100 years ago when Canada’s largest cities were beginning to establish themselves as major population centres. Even today, the vast majority of Canada’s trade is with the United States, providing economic incentive for population centres to be close to the border.

Overall, some 55 percent of Canadians live in the ten largest cities in Canada. That’s twice the share of Americans in the U.S.’s largest cities.

Census Metropolitan Area	Population	% of Population
Toronto	6,129,934	17%
Montreal	4,060,692	11%
Vancouver	2,504,340	7%
Calgary	1,439,756	4%
Edmonton	1,363,277	4%
Ottawa	1,332,001	4%
Quebec	806,359	2%
Winnipeg	793,428	2%
Hamilton	771,703	2%
Kitchener-Cambridge-Waterloo	511,319	1%
Top 10 CMAs	19,712,809	55%
Canada	35,985,751	100%

Source: Statistics Canada, 2015.

Metropolitan Statistical Area	Population	% of Population
New York	20,182,305	6%
Los Angeles	13,340,068	4%
Chicago	9,551,031	3%
Dallas	7,102,796	2%
Houston	6,656,947	2%
Washington, D.C.	6,097,684	2%
Philadelphia	6,069,875	2%
Miami	6,012,331	2%
Atlanta	5,710,795	2%
Boston	4,774,321	1%
Top 10 CMAs	85,498,153	27%
United States	321,418,820	100%

Source: U.S. Census Bureau, 2015.

The fact that so many of us live in just a handful of places means we generally live in big cities. Populations globally are increasingly moving into cities. So, while in theory we each have an enormous amount of space, when it comes to the housing market, Canadians choose to live big-city lives: Canada is a highly urban country.

Should we be surprised house prices in Canada are high when we all live in big cities? I don’t think so.

However, knowing some of the reasons Canadian house prices have risen doesn’t change the fact that housing here is expensive. So expensive that it’s gotten a lot of very smart people very concerned.