Cover your ears: Canada’s real estate market won’t shrug off this crisis like the last one

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Before COVID-19 struck, Canada’s real estate sector had been on a tear for two decades. Despite minor periodic lulls, the housing market kept on defying warnings of a major price correction even as household debt surged to record levels and income growth stagnated.

All the unfulfilled prophesies of a crash had made Canadians discount the downside risk of buying into a market that looked like a one-way bet. Investors kept piling in, too, confident they could rent their condos for a premium on Airbnb or flip them for a profit within a year.

Besides, they had friends in high places. Governments stoked the real estate market with “affordability” initiatives that drove up demand and won them votes. As Canada’s manufacturing and resource industries declined, governments looked to the real estate sector as an engine of economic growth. That made the Bank of Canada deathly afraid of removing the punch bowl of abnormally low interest rates, creating a property price bubble.

The coronavirus pandemic looks like the pin.

About 15 per cent of Canadian mortgage holders have taken advantage of six-month payment deferral programs offered by the big banks. That provides them with short-term relief but will add to their overall debt burden, as deferred interest is added to principal, leaving us facing what Canada Mortgage and Housing Corp. chief executive Evan Siddall calls a “debt deferral cliff” come fall. By then, a fifth of all mortgages could be in arrears amid the ugliest job market in decades. CMHC projects average house prices could decline by 9 per cent to 18 per cent by next spring.

If we’re lucky. With a debt-to-disposable income ratio expected to surpass 200 per cent by next year, the average Canadian household will be feeling materially poorer for a long time to come.

“The resulting combination of higher mortgage debt, declining house prices and increased unemployment is cause for concern for Canada’s longer-term financial stability,” Mr. Siddall told the House of Commons finance committee last week, suggesting that the minimum down payment on a home may need to be doubled to 10 per cent to cushion against future losses on the mortgage insurance the federal agency provides to millions of Canadians.

Raising the minimum down payment now might help protect Canada against a future property market crash, but it would not do much to avert a near-term one and might even contribute to a downturn by removing a slew of potential buyers from the market. The real question that needs to be asked is why policy makers have resisted proposing such solutions until now.

For years, governments talked about wanting to ensure a “soft landing” for our frothy real estate market. They took tentative steps to shorten maximum amortization periods, impose “stress tests” on some borrowers and slap a tax on foreign buyers in Toronto and British Columbia. But such measures proved insufficient in the face of the irrational exuberance of average Canadians, who had no problem borrowing sums amounting to several times their annual incomes.

Besides, faced with a prolonged downturn in the oil industry and a secular decline in the goods-producing sector, governments became even more reliant on housing to fuel economic growth. The finance, insurance and real estate (or FIRE) sector accounted for about 20 per cent of Canada’s gross domestic product by the end of 2019, up from about 16 per cent in 2000. Add in the residential construction industry and the figure rises to more than 25 per cent.

As recently as February, the housing-related economy was still firing on all cylinders. According to Statistics Canada, output in the real estate sector grew by 5.6 per cent year over year, compared with 2.1 per cent for the economy over all and far outpacing all other industries.

Now, most of those investor-owned condos in Toronto, Vancouver and Montreal that once fetched $200 a night or more on Airbnb are generating negative cash flows. Many of the 740,000 mortgage holders who have deferred payments face grim prospects in the coming months. A few segments of the market and regions of the country might escape the worst, but there is little likelihood the real estate sector can shrug off this recession as it did the last one.

Two of the most important fundamentals underlying real estate demand – household income growth and immigration – have been removed from the equation. That leaves the real estate market relying on only low interest rates to stay afloat. But low rates won’t be enough to sustain a market that had already been living on borrowed time.

By some miracle, the market has managed to defy the naysayers for several years, making Canada an outlier across most of the developed world. But unless the federal government, the CMHC and the Bank of Canada resort to even more extraordinary measures to backstop borrowers – and nothing would surprise us – Canada’s real estate exception is about to end.

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