Prices likely to drop but Canadian market very different than that of
TORONTO, Oct. 30, 2012 /CNW/ - Canada is not poised for an
American-style real estate meltdown, finds a new report from CIBC World
The report notes that while there are a number of factors that raise
concerns about Canada's housing market, there are fundamental
differences between the Canadian and U.S. markets that should see a
soft landing for the real estate market here.
"To be sure, house prices in Canada will probably fall in the coming
year or two, but any comparison to the American market of 2006 reflects
deep misunderstanding of the credit landscapes of the pre-crash
environment in the U.S. and today's Canadian market," says CIBC Deputy
Chief Economist Benjamin Tal.
He notes that while the debt-to-income ratio in Canada just broke the
American record set in 2006, "this ratio is more a headline grabber
than a serious analytical tool. There is a list of countries with
comparably higher debt-to-income ratios, which did not experience
anything remotely resembling the recent U.S. experience."
Mr. Tal says we should pay more attention to the speed at which the
debt-to-income ratio is growing. "Here the picture looks a bit less
alarming. Comparing the three years heading into the U.S. crash to the
past three years in Canada reveals that the debt-to-income ratio in
Canada has been rising at half the speed seen in the pre-crash U.S.
The strong growth in indebtedness south of the border was partially
fueled by speculative activity in the housing market - something we've
seen far less of in the Canadian market. In the decade leading to the
crash, housing starts in the U.S. exceeded household formation by
nearly 80 per cent. On average, over the past decade, the gap in Canada
has been only 10 per cent—with most of the excess seen in cities such
as Toronto and Vancouver.
Another key difference between Canada and the U.S. is in the quality of
mortgages. The distribution of credit scores has not changed
dramatically in the past four years in Canada which is a very different
story to what happened in the U.S. during the four years heading into
the recession. Stateside, the proportion in the risky category rose by
more than ten percentage points and accounted for 22 per cent of the
But credit score does not tell the whole story says Mr. Tal. He notes
that many of the troubled mortgages in the U.S. were sold to borrowers
with an acceptable credit score but who did not satisfy the
underwriting rules for prime loans because they were unable or
unwilling to provide full documentation on their mortgage applications.
In 2006, these non-prime mortgages accounted for no less than 33 per
cent of originations and close to 20 per cent of outstanding mortgages.
"An astonishing one-third of mortgages taken out in 2005 and 2006,
before the drop in prices, were in negative equity position, and no
less than half had less than five per cent equity, making them highly
exposed to even a modest decline in prices," adds Mr. Tal. "In Canada,
the negative equity position is nil, and only 15-20 per cent of new
originations have an equity position of less than 15 per cent.
Furthermore, we estimate that the non-conforming market is currently at
around seven per cent of mortgage outstanding, up from five per cent in
2005 but dramatically below the over 20 per cent seen in the U.S. at
the eve of the crash."
The report notes that, at its core, the U.S. meltdown is a
non-conforming story. Average house prices in cities with above-average
non-conforming exposure fell by 40 per cent from the June 2006
peak—double the decline in cities with below average exposure.
"Eradicate subprime from the U.S. housing market and, instead of the
most severe house price meltdown since the great depression, you get a
soft landing," states Mr. Tal.
In the U.S., a mortgage was typically 30 years compared to a 5-year term
in Canada. Traditionally, this made Canadian borrowers more sensitive
to the impact of interest rate hikes. In Canada today, borrowers are
already curbing their rate sensitivity by reducing the share of
variable rate mortgages in new originations to a multi-year low (mainly
among more risky mortgages).
"In the pre-crash U.S., the opposite was the case with the share of
adjustable rate mortgages (ARM) staying elevated until the bitter end,
with no less than 80 per cent of non-conforming originations being
ARMs," he adds. "And those mortgage gymnastics did not end here. The
introduction of the teaser rate, a low introductory rate for a period
of two or three years that would adjust upward at the end of the
initial period, worked to effectively neutralize U.S. monetary policy.
He notes that between mid-2004 and mid-2006, the Fed Funds rate rose by
more than 400 basis points, but in part due to the impact of the teaser
rate, the effective mortgage rate rose by only 30 basis points. The
practical implication of that was that when the teaser period expired,
millions of Americans felt the full impact of two years' worth of
monetary tightening virtually overnight.
"The reset of no less than $2 trillion of mortgage debt in 2006 and 2007
was no doubt the trigger to the U.S. housing crash. Such a potential
trigger does not exist in Canada with mortgage rates likely to rise
gradually, allowing borrowers to adjust over time."
Mr. Tal notes that not all is well in the Canadian housing market. Home
prices are overshooting their fundamentals, mainly in large cities such
as Toronto and Vancouver and the recent slowing in sales activity will
probably be followed by price adjustments in many cities across the
"But the Canada of today is very different than a pre-recession U.S.,
namely as far as borrower profiles are concerned. Therefore, when it
comes to jitters regarding a U.S.-type meltdown here at home, the only
thing we have to fear is fear itself."
The complete CIBC World Markets report is available at: http://research.cibcwm.com/economic_public/download/cw-20121030.pdf
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For further information:
Benjamin Tal, Deputy Chief Economist, CIBC World Markets Inc. at (416) 956-3698, firstname.lastname@example.org or Kevin dove, Communications and Public Affairs at 416-980-8835, email@example.com.