Here’s a portion of a blog post on Garth Turners site that attempts to summarize why RE in Canada is overpriced and due for a fall. For those of you who know or have heard of GT, he can be eccentric, and enough has been written about his past forecasts, predictions and there’s plenty you can find on the net on why GT shouldn’t be listened to. But you know, at the end of the day, at least he’s trying. Even if he is wrong, no one really doubts that prices are kinda out of whack right now.
One note, with forecasting and predicting over/under valued assets, you can be right, but the timing can be off by many many years. There’s a cardinal rule, in short selling overpriced stocks, you don’t short just because you think its overpriced-the reason being, you can’t predict the folly of people and the psychology of markets. You need a catalyst. Anyways, with that caveat, here it is:
Twenty-two Reasons Real Estate in Canada is Near a Top
1. Real estate valuations have reached record levels in their relationship to multiple long-term fundamentals. Current Canadian real estate valuations are all at record levels in relationship to; rental cost, average income, overall debt, and equivalent global values. When valuation metrics are at all time highs, caution is generally in order.
2. Canadian household debt levels are at record levels and are largely being ignored. Canadians moved counter to the global trend of deleveraging during the recent financial crisis and instead, increased their levels of personal debt. When the inevitable day comes to begin paying down the debt, the major driver of real estate will end too.
3. Real estate debt in Canada is at all time high levels. The growth of housing debt has substantially exceeded the growth of personal incomes.
4. Interest rates are at multi-generational low levels will not continue indefinitely. The presently low interest rates are masking the negative consequences of household debt and the ability to carry debt will deteriorate quickly when interest rates normalize. Low interest rates always send a message of “low risk” which results in misallocation of capital and ends with an asset bubble.
5. There is presently almost no awareness of the risk of contracting real estate values. When the risk to any asset class has been discounted to near zero and the value is only expected to increase, irrational exuberance will often be interrupted by another reality.
6. The Canadian real estate market did not fully experience a full correction that the US market did during the global financial crisis. Canada experienced an abbreviated version of a housing correction, in part, through extreme government intervention. This has emboldened the market to consider real estate as one of the safest investments.
7. Investor intelligence is at a low point. Fear and greed have taken over the real estate market and buyers will do anything to keep from being left out. Buying decisions tend to be easily reinforced because it is a familiar, practical and emotionally comforting asset class. There is also a general inability to rationally consider the economic costs of buying versus renting.
8. Employment growth in Canada is flat. In the past year, there has been almost no employment growth in Canada and the past six months have even shown negative growth.
9. Low interest rates and small down payments have made it possible for housing purchasers to acquire more home than would normally be possible. The access to additional levels of debt has expanded purchaser’s ability and desire to increase the values of their homes. Traditionally affordable properties are being turned into jewel boxes with much higher values.
10. When any asset class experiences multi-year increases in valuations it is cause for concern and not excitement. An increase in Canadian real estate prices in twelve out of the last thirteen years provides a strong indication that a correction may be overdue.
11. The combined policies of the Bank of Canada and CMHC have encouraged investment in real estate at the expense of the manufacturing sector. Capital and credit is a limited resource and has been increasingly directed towards real estate and away from productive manufacturing.
12. The present value of Canadian residential construction in relation to the overall economy is substantially greater than it was in the US at the peak of their market. Canadian residential construction now represents about 7% of GDP, while the US housing construction never contributed more than 5% of GDP. For more than a decade, residential housing construction has exceeded a sustainable contribution to the Canadian economy.
13. The total number of residential construction starts in Canada has remained above the long-term trend for more than a decade. Oversupply will always be the mortal enemy of prices in any economy.
14. Real estate market cycles tend to be long and they always overshoot to the upside just as they will eventually overshoot to the downside. Long term studies consistently show that prices in even widely diverse markets nearly always follow a similar pattern of reverting to their long term mean. Canadian real estate prices have not been within the mean range for well over a decade and are “technically” overdue for a major correction.
15. Real estate developer sentiment appears to be universally bullish. Record high prices are being paid with speculation on land that will not be available for development for five years and more. The input costs of land are being fixed at record levels and have no margin of safety for a correction in real estate values in the future.
16. Numerous major global financial institutions have sounded the warning on the risks of the overpriced housing market. These warnings are coming from some of the most unbiased perspectives and still the market remains undeterred.
17. The free market has not been allowed to operate efficiently in establishing the fair market value for real estate. Government intervention in the housing market through CMHC with more than $800,000,000,000.00 of financial backing of residential loans has had numerous unintended consequences. If left alone, the free markets would have assessed risk much more conservatively and the easy access to credit would not have prematurely drawn many marginal buyers into the real estate market. Housing and land would have remained much more affordable without this, and the intervention of extremely low Bank of Canada interest rates.
18. There is an investor disregard for the fact that real estate is a non-productive asset class. It produces nothing that may be sold and pays no dividend, but it carries a significant capital liability and has the regular cost of maintenance.
19. Baby boomers will begin exiting their real estate in a growing wave. Due to their limited financial investments apart from real estate, retiring boomers will begin a trend of liquidating real estate to fund retirement expenses.
20. Asset prices commonly accelerate towards the end of a bubble only to be immediately followed by a correction. Canadian house prices have recently had their biggest rise in the past two years. Fear of being left out of any remaining opportunity, the late investors panic as they finally get in at the tail end of the cycle. The early investors, blinded by the pride of entering the market sooner, continue to hold out for even greater profits.
21. Canada has the one of the highest rates of home ownership in the world. Spain and Ireland have higher rates of homeownership and are still experiencing a housing crisis, while Germany has a homeownership rate half of Canada’s and has avoided the global housing crisis altogether.
22. The strength of the real estate market is inspired by a false belief that “this time it is different”. It is never different, not even in Canada.