Tuesday, July 31, 2007

Vancouver Real Estate Bubble?

A blog posting by Vancouver Home Mortgage:

In today's Financial Post article
"Longer mortgages ease pain"
, Garry Marr quoted a report by Derek Holt, assistant chief economist with RBC. There are some issues mentioned on the report that are worth commenting:

"The recent trend to extend mortgage repayment plans to 40 years from 25 years has made consumers less sensitive to interest rate hikes"

"The housing cycle is being extended by new government policy - a reference to the Canadian Government's mortgage insurance rule by reducing the 25% down payment requirement to 20% this year"

The report attributed the changes in "driving up housing prices because consumers can deal with what Mr. Holt calls "down payment shock" by increasing the amortization period.

The above changes are exasperating the housing affordability situation (especially in Western Canadian cities) from bad to worse. While the above lending policy changes help in making home ownership easier, they are fueling demand and higher price gains on all housing units. But, I suspect these are not the main reasons why people are buying.

The real estate frenzy especially for Western Canadian cities like Vancouver, Victoria, Calgary and Edmonton is all consuming. Canadian home owners are happy with the huge price gains in their house values over the past 5 years. Many more people are encouraged to jump in for fear of loosing out as housing reports from real estate experts and economists are predicting another 7% to 8% price gain for the next 2 years?

Another point cited in the RBC report that "the changes in the borrowing practices in Canada have made the Canadian housing market less likely to implode as it has in the United States" is missing the point. It's the lending practices and not the borrowing practices in Canada that save us from facing a similar housing melt-down like the U.S.

The US housing markets are different from Canada in 2 major lending areas:

Firstly, the US sub-prime and "exotic" Variable Option mortgages as reported are as high as 25% of US mortgage origination. In Canada, the sub-prime lending hardly exceed 5% of all mortgages for the past 3 years.

Secondly, mortgage interest payment in the U.S is deductable as an expense, and this encourages more speculative buying and house price escalation in the U.S.

The housing implosion in the U.S. is due to many such option mortgages facing interest rate resets resulting in many home owners not able to afford the new mortgage payments. The housing price collapse in the U.S. is accelerated by tightened lending standards, and difficulties in home refinancing due to house prices worth less than the mortgages owing.

The Canadian housing cycle will take its course and unwind itself to a level when rental return and housing affordability are in balance. There is a disconnect between the average Canadian household income and average housing cost. As it is now, there is a "madness of crowd" mentality that if one is not jumping in to buy a home, or 2 or 3 (for speculation), they will miss the boat.

We, in Canada are faced with the following problems:

1) over-valued house prices - similar to the U.S.
2) major problem with housing affordability - maybe worse than the U.S.
3) over-supply of housing inventory (not apparent now)
4) bullish crowd mentality on real estate - people think we are different from U.S.
5) an economy exporting 80% to the U.S. - danger of economy contraction
6) Canadian loonie approaching parity with US$ - not through productivity gain

What are your thoughts?

1 comment:

John said...

Good post.
I would quibble with two areas of your commentary:
a) Canada is LESS dependent on US trade than ever before, with China and India replacing American trade...I think something on the order of "only" 65% of our exports go south of the border;
b) the fact that mortgage payments are deductible in the US IMPROVES affordability there, and restricts it here.

I would also add that we have already seen a slight east-to-west cooling, a plateau perhaps, in prices -- Calgary has already plateaued and more properties are on the market and for longer periods of time, with occasional price declines, too.