Canadian Housing Can't "Crash" - but that's not the only way down

Wednesday Jul 07th, 2021


A market "crash"​ isn't the only way down.

To me, a "crash" implies that prices fall so quickly that people don't have time to escape.

This creates a trap in which financial stress can be spread across the entire economy. See America, 2008.

In a normal year, it's very difficult for this to happen in Canada due to the structure of our financial system and courts. In present day, it's nearly impossible because of the state of our court system.

Terminal Velocity

The last time we saw a test of the potential velocity of price decline in Canadian real estate was in Q1 2017, as Greater Toronto Area detached properties corrected 20-40% as a response to the NRST.

It took about 16 months from peak-to-trough in that correction, from about April of 2017 to August of 2018:

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Sometime in 2019, I ignorantly wrote about my fear for those mortgages needing to renew in 5 years because their valuations would have been below their purchase price.

I received the following response from a financier who places hundreds of millions of mortgages per year:

"Valuation doesn't matter. The lender will just check the renewal box."

I learned something about renewals that day, but I still couldn't dismiss the risk associated with those massively-inflated 2017 purchases. I exclaimed that they were already cash-negative rentals, even though they were purchased at record-low interest rates. Spreads were increasing at this time, and we were in an increasing interest-rate environment. Even if the valuation didn't matter, I thought, these assets would become painful liabilities to the owners when they had to renew at a higher rate.

Had we not seen a global pandemic, I may have been right.

But it doesn't really matter whether or not I was right. By 2021, regardless of pandemic response, many of those assets would have earned 10-20% of their equity through rental income, and most will had recovered to a value 10-15% below their purchase price. At the end of a mortgage term, the worst would be behind them, and their banks would support their future.

The reality is that price just can't "crash" in Canada. This is not to say that consumers are protected by the market. There are thousands of examples of 2017 buyers who suffered extreme financial stress as a result of overpriced property. There are thousands of examples of 2021 buyers who are suffering financial stress as a result of bad fundamentals. Distressed property deals are as one-off as those experiencing these buyer-beware woes. Our system is built to relieve risk for banks, rather than consumers. Price goes up much faster than it goes down, and there's a reason for that.

Cleveland Fed: "Why didn't Canada's housing bust"

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I believe the reason is because we don't really have nationally standardized system of forbearance and/or foreclosure (it varies provincially), but we do have a nationally standardized system of lending, with rules established through competition, by an oligopoly of 6 banks. In order to see a national price-decline-velocity similar to the USA in 2008, you'd need a fire sale scenario to happen in Canadian property. It also requires that said fire sale is met with an absence of excess demand, which is an entirely different problem.

In order for a fire-sale to happen, you'd need:

  1. Lenders that have the means to take back property (foreclosure);
  2. Lenders that have a reason to take back property (default);
  3. Lenders that have a willingness to take back property; and
  4. Lenders that have an incentive to take back property.

In today's market, most lenders only have one of the four of the above criteria, and they're only entitled to #1 in certain provinces:

  • A power of sale takes place when a lender uses lawyers to force the owner to sell a property, as agreed upon within the mortgage commitment contract.
  • foreclosure takes place when a lender uses the court system to take possession of a property in order to sell it.

"The primary difference between a Power of Sale and foreclosure is that the former does not require the use of the court system. That’s why the process is much faster and can even result in a completed process within a few short weeks.

On the other hand, foreclosure can be a painfully long process that often doesn’t see any sign of resolution until months later, sometimes as long as a year. Foreclosures are more common in the provinces of BC, Alberta, Manitoba, Saskatchewan, Quebec, and Nova Scotia."


This distinction is important because courts are backed up, so the likelihood of getting a foreclosure on a proper timeline is less realistic than when the above statement was written.

There are also a handful of important correlations and mutual exclusivities to consider regarding the fire-sale criteria. Fore example, if a property is in default, there is a higher likelihood that it is not a good asset. This means that there is an conflict of (4)incentive between (2)reason and (3)willingness.

The only question I have left is regarding correlation between price growth velocity and price decline velocity. Specifically, does the rate at which we get to peak determine the rate at which we get to trough?

Beyond 2017-2018, historic declines in Canadian price history took 5, 11, and 7 years from peak-to-trough.

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Minced Words

The Bank of Canada et al had been pretty vague about the risk that exists within our debt-fuelled economy. Presumably, this is because their monetary policy pandemic response has indisputably exacerbated most debt metrics (except individual cost of capital), while the government's fiscal policy (helicopter money) increased the average household savings rate (albeit less than debt).

Now, the Bank of Canada seems to have changed their tune a bit.

Yes, price can (and probably will) decline. But it can't crash.

I've said this enough times for people who follow me to know this is exactly what I believe:

The next drop in Canadian housing prices will take a long time.

If we see a decline in Canadian housing, it'll happen for a variety of reasons:

  1. Immigration targets aren't met (and excess demand will slow with it);
  2. Job targets aren't met;
  3. Financial stress will catch up to the demand side;
  4. Rents and rental delinquency will catch up to 2021 investors;
  5. People will have a hard time paying their renewed their mortgages in 2026+

All of these things take time.

None of these things really create the fire-sale scenario necessary for a crash.

Eventually, the perpetually growing credit cycle we've created will get into its "payback" period. I believe this credit cycle has actually outsized our economy, which could be very problematic. I'm working on quantifying this.

We may have dodged the nonexistent renewal-bullet I mistakenly suspected on 2017 purchases. But this time around, valuation won't be the problem on 5-year mortgage renewal. Even a historically small increase in interest rates within the next 5 years could create a house-poor scenario for a lot of 2021 buyers, and will turn the assets of many 2021 investors into liabilities, almost all of whom are already cash-negative. At current record-low rates, it's not fantastical to imagine a 50% increase in capital cost by 2026.

On the bright side, this gives market participants ample time to trade in and out of the market, and is honestly probably the healthiest thing that could happen with our market. There will be money to be made and lost, there will

I think that the Canadian government has exhausted nearly every monetary & fiscal policy tool we have to keep property values moving up without massively destroying the domestic buying power of the Canadian dollar. We're seeing quantitative easing bond purchases tapering (the majority of which come from our Big 6 banks anyways) so credit creation could slow. There is indication that rates could rise.

Most of what we need to know has been written. The rest is up to consumers.

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Real estate.
"We may have dodged the nonexistent renewal-bullet I mistakenly suspected on 2017 purchases. But this time around, valuation won't be the problem on 5-year mortgage renewal. Even a historically small increase in interest rates within the next 5 years could create a house-poor scenario for a lot of 2021 buyers, and will turn the assets of many 2021 investors into liabilities, almost all of whom are already cash-negative." hashtagmortgage hashtagrealestate hashtagrealtor hashtaginterestrates hashtaginvestment hashtagtorontorealestate hashtagtorontorealtor hashtagcanadianrealestate hashtagcanadianhousing hashtagcdnecon

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