Immigration Canada

Canada’s housing market flirts with bubble

By Warangkana Chomchuen

NEW YORK (MarketWatch) — Rising home prices over the past decade, combined with mounting household debts, have fed concerns that Canada’s housing market has formed a bubble that’s about to burst.

“We call it a tug of war,” said Sonya Gulati, economist in regional economies, housing and government finance at TD Economics, an affiliate of Toronto-Dominion Bank. “Low interest rates make people want to participate in the housing market, but with modest growth, not strong job creation, we can see a negative repercussion on the horizon.”

A crash, or even sharp retreat, in home prices would contrast to the resilience of Canada’s housing market during the economic downturn, particularly compared to its U.S. counterpart.

Average American home prices have plunged 34% from their peak in April 2006 as of the most recent reading in December. In Canada, national average house prices fell 9% from their peak in August 2008 before they bottomed in April 2009, separate indexes from Teranet-National Bank of Canada and S&P/Case-Shiller show.

The U.S. housing market has recently started to improve, but it’s still far from prerecession levels. Sales of U.S. existing homes rose 4.3% in January, reaching the highest pace since May 2010, the National Association of Realtors said. However, American home prices in December fell to their lowest level since the housing crisis.Read more on U.S. home sales.

Relaxed lending standards in the U.S. and a Federal Reserve policy that kept interest rates at 1% for a full year before the central bank started to gradually raise them were blamed for the rapid gains in U.S. home prices until their peak in 2006, pushing values to unsustainable highs.

Canada discouraged overborrowing and limited its banks’ exposure to subprime lending with more conservative regulations and lending standards. Borrowers had to show employment and income records to take loans, while Canadian mortgage rates were kept higher than the U.S. rates over the same period to avoid boom-time price increases.

Canadians pile on debt

Canadian homeowners weren’t immune from the global financial crisis. But after home prices started to recover three years ago, Canadians have seen a sharp run-up in house prices relative to income, as well as excess real-estate inventories. Their bank accounts show a historic high debt-to-income ratio, spurred by ultralow interest rates.

The Bank of Canada announced on Thursday it would maintain its interest rate at 1%, which the central bank has kept steady since September 2010.

House prices in Canada have doubled in the past decade, with double-digit growth in the past few years. In British Columbia and Ontario, for instance, prices grew by 41% and 29% since their crisis troughs in the past few years, according to a 2011 country report on Canada by the International Monetary Fund.

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Fed: Banks can weather downturn

The Fed cleared the way for many of the nation's largest banks to raise dividends and buy back shares as it released the results of its latest round of "stress tests." Photo: Getty Images

Alongside these gains, Canadian homeowners have become more debt-strapped. The level of household debt relative to disposable income has accelerated to 153% in 2011, versus 110% in 1999, Statistics Canada said.

These levels bear an eerie similarity to U.S. households’ debt burden before the financial crisis. The U.S. debt-to-income ratio climbed to its peak at 130% in the third quarter of 2007, according to the Federal Reserve’s Flow of Funds report. Much of the sluggish U.S. economic recovery has been blamed on a massive deleveraging by these debt-strapped consumers.

Though not a perfect metric, the rising trend in the debt-to-income ratio “flags the fact that Canadians are becoming more leveraged and are more vulnerable to an economic shock than they were heading into to 2008/2009 recession,” Craig Alexander, chief economist at TD Bank, said in a report.

“Housing contributed positively to the boom years and it will have a negative impact on broader economy when the market unwinds,” said David Madani, Canada economist at Capital Economics.

Supply glut

Immigration and population growth in Canada, which has grown 5.9% from 2006 to 2011, help drive housing demands. But the population growth in some cities can no longer keep up with real-estate inventories.

The greater Toronto area has experienced a boom in high-rise condominiums in recent years. Housing starts are approximately 40,000 per year, exceeding the demographic need of about 18,000 to 25,000 units, Gulati, of TD Economics, said.

“The number is not going to be sustained,” Gulati said. “There’s going to be a gradual unwinding of excess in the next few years. The competition between new and resale markets will lead to a negative repercussion in terms of price.”

Fallout from a housing crash would hit Canada’s biggest banks hard.

Canada’s big five banks — Royal Bank of Canada CA:RY +2.15% RY +2.47% , Toronto-Dominion Bank CA:TD +1.18% TD -0.08% , Canadian Imperial Bank of CommerceCA:CM +1.78% CM +2.13% , Bank of Nova Scotia CA:BNS +0.46% BNS -0.32% , Bank of Montreal CA:BMO +1.65% BMO -0.44% — are top lenders, now holding about 62% of the C$1.1 trillion mortgage market in Canada, according to mortgage market share data compiled by Canadian Mortgage Trends.

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Some economists said the housing concerns, though warranted, are slightly overblown for the near term. Gradual moderation and correction in housing market are likely.

In a forecast released in February, Canada Mortgage and Housing Corporation, the government-owned housing corporation, said it expected the housing market to remain “steady” for 2012 and 2013.

“We see housing market slowing down, but we don’t believe there’s a bubble in Canadian market right now,” said Benoit Durocher, senior economist at Desjardins.

Durocher noted that the main risk for housing market is Canada’s economic condition. An increase in mortgage rates, modest job creation, and external shocks from weak economic recovery are possible triggers.

Growth sputters

Canada’s economy is set to grow at modest pace. Gross domestic product fell to an annualized rate of 1.8% for the final quarter last year, from 4.2% in the third quarter. The U.S. economy grew at an annual rate of 3% in the final quarter 2011.

Bank of Canada estimates that Canada’s economy will grow at 2% in 2012, down from 2.5% in 2011, and at 2.8% in 2013.

Canada economy lost 2,800 jobs in February, putting the job gain total to around zero in 2012. However, the exit of 38,000 people from the work force helped push the unemployment rate down to 7.4%, from 7.6% in January, Statistics Canada reported.

Much of Canada’s economic strength in recent years has derived from its strong natural-resource exports, which have benefited from China’s surging demand. That’s also its vulnerability.

“A decline in foreign demand for Canadian exports and weaker commodity prices in the context of increased global risk aversion could lead to higher unemployment in Canada and a downturn in house prices,” Canada report by the IMF said.

Fewer mortgage perks

But compared to the U.S., Canada still has some structural supports that should help its housing market, said Mazen Issa, Canada macro economist at TD Securities.

Unlike in the U.S., mortgage interest is not tax deductible in Canada, reducing an incentive to take out mortgages.

Defaulting Canadian borrowers continue to be responsible for repaying the full amount of the loan even in the case of foreclosure. In the U.S., lenders cannot recoup money from the homeowner beyond the property if borrowers decide to walk away from their home and mortgage loan.

Home affordability, supported by low interest rates, could be another buffer to a housing collapse.

Sales of existing homes are predicted to rise 0.3% this year but the average home price is expected to fall 1.1%, the Canadian Real Estate Association said in its quarterly forecast this month.

“Low interest rates should hold affordability in check for some time, allowing incomes to catch up with higher prices and restore proper valuations,” Sherry Cooper and Sal Guatieri, economists at the Bank of Montreal, said in a special housing report in January.

Madani, economist at Capital Economics, counters it is a “wishful thinking” that income growth will close the gap between house prices and income. Focusing on house affordability ignores borrowers’ abilities to commit to repay their loans over decades.

“If you buy a home today, that’s one thing,” Madani said. “But you have to be able to pay in 25 to 30 years; it’s more than just the ability to buy a house in today’s market.”

A five-year fixed rate mortgage with a 25-year or 30-year amortization period is the most common mortgage product in Canada, as opposed to the 30-year fixed mortgage mainstay in the U.S. This means that by the end of the five-year term when Canadian borrowers have to renew their rates, they may not realize what an increase in mortgage rates will mean for their personal income and monthly payments, Madani said.

Canadian policy makers, mindful of the destruction wreaked on the U.S. economy by its housing market collapse, have been introducing new measures to prevent borrowers from overstretching.

Finance Minister Jim Flaherty has tightened mortgage lending rules three times since October 2008, recently reducing the maximum term of publicly insured mortgages to 30 years from 35 years.

Banks also started enforcing lending policies on the self-employed and new immigrants.

Nonetheless, mortgage rates that remain exceptionally low risk fostering further, possibly precarious rise in home prices.

“In the last 10-20 years, we see bubbles in commodities, in housing, in the markets,” Madani said. “Is there any great surprise? Canada is not different from other country.”

Desperate for workers, West seeks immigration powers

JUSTINE HUNTER AND DAWN WALTON

VICTORIA AND CALGARY— From Monday's Globe and Mail

Canada’s Western premiers are seeking to wrest control over immigration away from Ottawa to help the West manage its growing skills shortage.

“We are well-positioned but we need to have a national discussion about what further tools provinces need to grow the national economy,” said B.C. Premier Christy Clark, who is leading the group, in an interview.

The biggest one for us in the West is immigration. It’s one of the most important economic levers any government has and we don’t have it. ... We need to devolve immigration to provincial governments.”

Ms. Clark has the backing of Alberta Premier Alison Redford and Saskatchewan Premier Brad Wall, who are facing similar labour and skills shortages. They are eyeing Quebec’s immigration authority with envy.

As Ottawa struggles with a huge backlog of immigration applications, the provinces, especially in the fast-growing West, are increasingly frustrated with their inability to bring in needed workers.

Ms. Clark was in Ottawa last week but did not formally raise the immigration issue, waiting instead for a task-force report she commissioned to help build B.C.’s case.

In her current jobs plan, Ms. Clark expects B.C.’s economy to grow by one million jobs over the next decade, and a third of those jobs will need to be filled by immigrants.

Under the Provincial Nominee Program, which allows provinces to put forward candidates who want to invest and run a business for accelerated immigration, B.C. can bring in 3,500 skilled workers or entrepreneurs. B.C. wants that figure to rise to 5,000 this year and 6,500 a year after that.

“We wish there were no caps, but if there are caps we’d like them to be higher than they are,” said Liberal MLA John Yap, who led the task force. “Ultimately it would be nice to have what Quebec has. Failing that, we would like to have discussions with the federal government to let us have a greater share of the immigration process, in the context of the growth we are forecasting,” he said.

Mr. Yap’s report is due on the Premier’s desk by the end of the month. He has already travelled the province holding a series of forums to assess how to increase the number of skilled immigrants and investors in British Columbia.

Mr. Yap said he heard from businesses big and small that are frustrated about the lack of skilled workers now – and the challenge is expected to grow as B.C.’s aging population fails to produce enough skilled workers to maintain even the status quo.

“A small business owner in Prince George said he cannot bring in welders fast enough,” Mr. Yap recalled from his road show. In Fort St. John, representatives from the oil and gas industry sounded “desperate” for workers. In Cranbrook, he heard the same message from a mining company that says it needs 1,000 skilled workers to develop projects.

“The long term trend is clear,” Mr. Yap said. “Over the next 10 years we have so many people leaving the workforce and not enough people here to fill those positions. We need to fill the gap with immigration.”

Saskatchewan’s premier is also looking to persuade Ottawa to relinquish some of its control over immigration in order to source workers for both skilled and general labour shortages facing his province.

“As strong as I think the component parts feel they are able to respond to their own unique economic challenges, the devolution of that kind of influence especially in terms of immigration policy is pretty key,” Mr. Wall said.

“One of barriers to continued growth is the human resources. We have skilled labour shortage. We have a general labour shortage,” he said in an interview.

In Alberta, Ms. Redford is also anxious to see Ottawa hand over some power to the provinces with respect to immigration.

“I think we agree very much on that,” she said of her provincial counterparts in the West. “In Alberta, labour issues are paramount for us just to counter inflationary cycles and I think we are very much on the same page with respect to that in order to continue to allow the economy to grow, not just for our own benefit, but for Canada’s benefit, we need to see some more flexibility on that.”