What goes up must come down; and in regard to Canada’s housing market, a crash certainly seems likely at some point. After all, ever since the Bank of Canada lowered Canadian interest rates in the wake of the COVID-19 pandemic, there has been a massive spike in home prices, and many experts are predicting that a correction is forthcoming. In this article, I will be analyzing both the causes of the housing bubble and a few of the biggest risk factors currently at play to argue why I think a market correction is bound to occur at some point in the future.


The Effects of COVID-19 on the Canadian Housing Market 

So, how did we get to where we are today? Well, as soon as the COVID-19 crash hit, real estate was just as hard hit as any other asset class; in fact, the total value of Canadian residential building permits in April was down 22% from February levels, while home resales plunged a whopping 57% and newly listed homes declined by 56%. However, it did not take long for a recovery to come about.

On one hand, the federal government and central bank stepped in with several different stimulus programs. While measures such as unemployment assistance and six-month deferrals on mortgage payments were major examples, chief among them was the decision to lower interest rates, which led to increased borrowing and confidence in the market. However, beyond financial indicators, the softening of lockdowns and the expansion of both socially distanced and virtual showings also helped increase market participation, while the re-opening of many construction sites due to the construction sector being deemed an essential service helped ensure that the supply of new homes was maintained.

Demand was also furthered by the increase in work from home policies, as they caused many people to permanently or semi-permanently relocate their office to their home and, consequently, desire a larger living space in order to accommodate for the greater amount of time spent there.

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When combined, these factors helped spur market activity, and due to the government’s fiscal and monetary policies, houses temporarily became more affordable. According to the Bank of Canada’s Housing Affordability Index, the affordability of houses in the second quarter of 2020 improved to levels that have not been seen since the second quarter of 2013, and this was largely thanks to the fact that disposable incomes had risen due to the affordability of loans. While this created a boom, this rise was also met with a rise in the level of average household debt.

According to Stats Canada, the average mortgage debt service ratio, which calculates one’s debt to income in the realm of mortgage payments, jumped from a mere 5.80 in the second quarter of 2020 to 6.35 by the third quarter and 6.54 by the fourth quarter, representing a 13% increase in the span of just six months.

Of course, it should be noted that these effects were not symmetrical across the country. For example, in the prairie provinces, the drop in oil prices during the summer months of 2020 overshadowed the effects of the stimulus by creating market uncertainty. As a result, according to Canadian real estate company RE/MAX, average housing prices in major prairie cities only increased slightly from 2019 to 2020, with real estate appreciating by just 0.03% in Calgary, 1% in Edmonton, 2% in Regina, and 4% in Winnipeg.

In most other municipal housing markets, the effects of the stimulus have helped create a bubble with unsustainably high annual returns of 11.4% in Vancouver, 12% in Toronto, and 12% in Halifax, while smaller Ontario cities such as Niagara, Collingwood, and Muskoka seeing exceptionally high returns of 19%, 19.5%, and 20.3% respectively. And while a wealth of data for 2021 is not yet available, figures compiled by the Canadian Real Estate Association found that, on average, prices have risen an average of 41.9% across the country from February of 2020 to February of 2021, and this trend of increased price levels has continued until today.


Canadian Housing Market: A Large Recovery

So, why is this a problem, you may ask? Well, to put it simply, the average annual rates of return across the country this year are nowhere near the average annual returns during a typical year. According to the Canada Composite Housing Index, the average rate of return over the past 15 years has been about 6.11%, making this year’s returns of 41.9% from April of 2020 to April of 2021 almost seven times the normal rate of return. That’s not to mention the fact that according to data collected by Teranet- National Bank of Canada, the change in real estate prices is roughly comparable to that seen in the recovery after the 2008 Recession.

If we look at the historical data, we realize that, just like with most assets, the real estate market is cyclical. Now, don’t get me wrong; it is clear that over time, Canadian housing price indexes generally follow an upwards trend, as do other indexes such as the S&P 500 and the NASDAQ Composite. However, the change in price is prone to drastic upturns and downturns. As shown by Teranet-National Bank of Canada, it is not unusual for the percent change in real estate prices to change dramatically from year to year, and this volatility can make it quite difficult for the average real estate investor to accurately predict the annual ROI of their assets.


Bank of Canada’s Latest Updates on the Canadian Housing Market 

Beyond the available data, it should also be noted that the Bank of Canada has recently come out with some pretty concerning news. In a report published in April of 2021 entitled Update on housing market imbalances and household indebtedness, Bank of Canada analysts Mikael Khan, Olga Bilyk, and Matthew Ackman have noted two concerning trends. The first is that due to demands for more space, homebuyers have generally been shifting from buying small condominiums to buying larger single family units in suburban and rural areas.

Once the pandemic is over and people return to work in person, this trend may dramatically shift as people look for units closer to their workplaces, and thus dramatically lower the prices of the single-family homes that have been so hot during the pandemic. The other major concern is that new mortgages to highly indebted households have risen by about 75% from their pre-pandemic levels. Since these types of loans are riskier by nature than loans to less indebted households, the chance of default once the effects of the stimulus wear off is larger, and this has therefore increased the volatility of the market.

If these indicators weren’t troubling enough, it is also worth noting that the Bank of Canada has signaled to home buyers that interest rates will soon be on the rise. That’s because it recently formalized a proposal to make it more difficult for homebuyers to secure financing. Under the set of new qualification rules that go into effect on June 1st, buyers will have to show that they can afford a minimum interest rate of 5.25% despite the fact that interest rates are currently lower than that figure. Therefore, this is a sign that the Bank of Canada will eventually raise interest rates to somewhere closer to 5.25%, and this would lead to a market slowdown and a potential devaluing of real estate across the board.


Canadian Housing Market : The Conclusion

To conclude, if there is anything I would like to impart on you today, it is this: that markets are cyclical. Therefore, while real estate may be doing well today, bull markets cannot last forever. To be completely clear, do keep in mind that if you can afford a house and are looking for a place to live, I am not trying to dissuade you; after all, leaving your parents’ basement, short term rental, or other temporary arrangement and living on your own is important!

If you are borrowing heavily in today’s low-interest environment with the expectation that your ROI will be higher than your interest payments well into the future, then make sure that you understand the risks. After all, while the real estate market hasn’t crashed in the recent past, that doesn’t mean that it cannot crash; therefore, I advise you to do your research and evaluate your risk tolerance before buying any real estate!

And if my research and analysis wasn’t enough to persuade you, then I leave you with the wise warning that Bank of Canada Governor Tiff Macklem delivered on May 20th of 2021: “Canadians need to be prudent in taking on new debt. It’s important to understand that the recent rapid increases in home prices are not normal. Even without a shock, some of the factors that cause houses to rise fast could reverse later, and that could leave some households with less equity in their homes…counting on ever-higher house prices to build home equity that can be used to refinance mortgages in the future is a bad idea.”

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