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The long shadow over Canada's housing market (Alexei Vella/Alexei Vella for The Globe and Mail)
The long shadow over Canada's housing market (Alexei Vella/Alexei Vella for The Globe and Mail)

The long shadow over Canada's housing market Add to ...

Wake up, Canada: The house party is over.

A wide range of indicators say Canada can no longer count on a booming housing market to keep the economic blues at bay. But in the quarters where it most needs to be heard, the message is not resonating.

Many policy makers have yet to adjust their view of a market that just last spring was helping the economy rebound from the recession. Sales of existing homes were setting records month after month; a generous tax credit had encouraged the masses to take on renovation projects; new home starts were hitting all-time highs.

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Victor Fiume, president of the Canadian Home Builders' Association, remembers speaking at a meeting of municipal leaders at the height of the boom. "They were bouncing down the stairs with excitement about what it meant to their tax base."

Many of them are still holding on to those hopes, even as the market slows.

"Now they're looking at me like I have two heads," Mr. Fiume, who is also general manager of Durham Custom Homes in Oshawa, Ont., says of the local politicians. "They find it very difficult to believe we can come to such an abrupt halt."

The trouble is not that Canada is on the brink of a gruesome real estate bust like the U.S. - because it isn't. It has been shielded by more cautious lending practices, and avoided such bad practices as zero-down-payment or no-documentation mortgages. With few exceptions, Canadians have equity in their homes.

Mortgage defaults are minimal. Housing speculation never reached the absurd levels that it did in such Sun Belt states as Nevada and Arizona, and the federal government has taken steps to ensure that it never does, in part by requiring much higher down payments for investment properties. There is a lot that is good about the structure of the Canadian property market.

But a period of stagnation or slowly falling prices, coupled with weak home sales and waning construction activity, would cut off one of the engines that drove impressive economic growth and job creation in the years before the 2008 financial crisis.

This week, when the Bank of Canada released its latest report on the domestic economy, it specifically mentioned the prospect of "a more pronounced correction in the Canadian housing market" as one of three key risks.

The primary reason for that, of course, is the mountain of debt carried by many Canadian households, which has worried the central bank governor for many months. Toronto-Dominion Bank said this week that Canadians will soon owe more than $1.50 for every dollar of disposable income, an unprecedented level. And home prices are already stretched far beyond their historical norms, particularly in the largest urban markets such as Vancouver.

It all adds up to a simple, unpleasant equation: High debts, plus high home prices, plus high unemployment, plus slow growth in incomes, equals a housing market that's much different than the one Canadians are used to. Is it any wonder that, after 10 years of explosive growth, the housing market appears out of gas? Sales fell by as much as 45 per cent in the country's largest cities over the summer and haven't recovered through the traditionally brisk fall market.

That means the summer effectively wiped out a year's worth of gains, with the average resale price back at year-ago levels. New construction fared little better, with the seasonally adjusted rate of starts falling to 186,000 in September from April's peak of 201,900.

That has dramatic implications for employment and consumer spending levels - and for an economy that has grown accustomed to relying on housing-related spending for about 20 per cent of its gross domestic product.

"Canada doesn't need a U.S.-style problem to have a problem," said Alexandre Pestov, a market analyst at Three Bears Research in Toronto. "A Canadian-style issue will do just fine."

The threat to come

As economists debate what comes next in the real estate sector, they're surveying unfamiliar terrain: The country has never been in quite this situation before. Any one of the series of obstacles facing the housing market has the potential to wipe out billions of dollars of household wealth and stall the economy.

Interest rates are at record lows, but will inevitably move higher and price some people out of their homes. Prices have soared far beyond the rate of inflation for most of the past three years. Over the past decade, average prices have increased 121 per cent to $331,089.

The OECD called Canada's housing market "overpriced" in a recent report, adding that 7.5 per cent of Canadian households could find themselves in trouble by the middle of 2012 if interest rates rise, as they're expected to do.

Prices have finally reached the point where they've scared some buyers out of the market. The Canadian Real Estate Association has reported that September sales numbers gained an anemic 3 per cent, after declining as much as 45 per cent in some cities (such as Vancouver) through the summer.

Home prices, which shot upward in the spring, have reverted back to levels last seen a year ago, effectively erasing a year of gains. Higher interest rates in the next year are expected to further quell the market.

Market forecasters are near-unanimous in the belief that prices will fall in the coming years, though few foresee the sort of rapid declines that savaged the American market. The stateside disaster was largely fuelled by loans made to people who weren't creditworthy. Canada's problem is different - easy credit is luring people into buying houses they may not be able to afford when rates rise to more historically normal levels. That's why economists and market watchers foresee a drawn-out retraction of the market that will gradually erode prices, rather than a crash.

The effects of a slow burn can still be devastating, however. Among those most affected are property developers, real estate agents, investors who hope to flip houses, municipalities that rely on revenue from building permits and housing construction, and baby boomers planning to cash out their homes to finance their retirement.

Housing-related spending - including the rental market and the sale of existing homes - accounts for about 20 per cent of gross domestic product in Canada, the Canada Mortgage and Housing Corp. stated in its annual report released in late September. (Statistics Canada only counts residential construction's impact on the economy in its GDP estimate, which it places at a 7 per cent share.)

It's the highest level CMHC has recorded in a decade, and translated into $307-billion in economic output in 2009. And that means the impact of a slip in prices is greater than it would have been only a decade ago when it accounted for $184-billion in spending.

If home resale prices were to fall just 5 per cent, $10-billion would be sucked from the economy, said Benjamin Tal, deputy chief economist at CIBC World Markets. Consumers, worried about their falling net worth, would stop spending on things such as restaurants and shopping trips.

"The housing market of the last 10 years has been very important in terms of the wealth effect," Mr. Tal said "And I can tell you, the next decade will be much weaker. Does this have consequences for the broader economy? Of course it does."

And that's merely the effect of a decline in the value of existing homes. Any housing slowdown usually comes with a major impact on new home construction - and it played a pivotal role in the rapid healing of Canada's labour market after the recession.

About 35 per cent of all jobs created through the recovery can be traced back to construction, according to the Canadian Home Builders' Association, with home builders accounting for the majority of the activity. But much of the work taking place today harkens back to sales made last year, when the industry set new sales records.

"We're still building houses we sold in the spring," said Mr. Fiume, the home builders' president. "But at some point we're going to finish that work, and the unemployment rate is going to take a hit because we'll be laying off workers. Then, more than ever, people will understand why it's important to have a strong housing market."

A staid housing market

The slide may have already begun, although a lack of interest on the part of buyers has so far been mitigated by a lack of new inventory hitting the market.

New listings were static in September, according to CREA, down 15 per cent from April's peak. The number of months of inventory in Canada, on a seasonally adjusted level, stood at 6.6 months at the end of September. That's how long it would take to sell all the listed houses at the current pace of sales.

And while supply and demand are keeping prices firm, few expect that to last over the next two years. CIBC World Markets has suggested prices could fall as much as 10 per cent in the next two years, as has TD Bank. CREA suggested at the end of July that prices could slip 1.2 per cent by the end of the year, and fall 0.9 per cent next year.

CMHC is the lone dissenter among the market watchers, saying only that average resale prices are "expected to edge lower through the end of 2010 and then rise modestly in 2011."

It's not exactly a ringing endorsement.

"The next decade will be weak," Mr. Tal concedes. "In the next year we should see negative growth, with places like Vancouver maybe even seeing a 20 per cent decline. Maybe we will see prices moving with inflation across the country after that, but no more. I do not think it will be a crash that will send people jumping out of windows, but the housing market of the future will be a very boring place."

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REAL ESTATE BUBBLES

When it comes to Canadian real estate bubbles, there have been two loud pops.

The Canadian Centre for Policy Alternatives believes another one is imminent, because of the way prices have pulled away from inflation. Between 1980 and 2000, the historical price range for housing in Canada held steady between $50,000 and $80,000 in inflation-adjusted 1980 dollars.

Between 2001-06, all major housing markets in Canada shot to well above the $80,000 average that had been the norm for 20 years. The average price of housing in Canada's cheapest markets topped $100,000 in 2010.

Toronto 1989

While this ugly period for Toronto housing is often referred to as a crash, it actually took five years for prices to finish their swoon. The market was pumped up through the 1980s by record-low unemployment rates and relatively low interest rates. But as the decade neared its end, rates began creeping higher until they peaked at just over 14 per cent in 1989. This set the market back, and in five years prices fell 27 per cent as unemployment climbed about 11 per cent.

Vancouver 1994

The Vancouver crash took just three years to play out, with prices falling 16 per cent. Price gains had been fuelled by immigration, which cooled through the mid-1990s and affected demand for housing. Relatively lower interest rates through the early part of the decade also helped fuel demand, which took years to recover.

Steve Ladurantaye

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