Canadian Real Estate Bubble?
– Aman Azad, C.E.O. Azad Real Estate Group Ltd.
It’s time to weigh in on the big question many people across the Canadian Real Estate landscape are asking. Is there a Real Estate bubble in Canada?
At this point, it may be too early to make a definitive declaration on this matter. However, when looking at some of the key factors in the equation, the argument that a bubble exists becomes much stronger.
Overactive Lending Environment
With interest rates at an all time low, and a wide range of accessible mortgage products, the sheer number of borrowers have skyrocketed since 2006. Borrowing costs currently remain relatively low, allowing for affordability to become more widespread. This environment has also created a noticeable increase in mortgage fraud and the manipulation of affordability by loans officers.
Concentrated Foreign Investment
Since 2008, there has been a steady wave of foreign buyers purchasing in national hotspots, such as Vancouver, Toronto, and Montreal. Most of these foreign buyers are from countries for which there is a large diaspora located within these regions in Canada. Tightening government regulations and political pressures in these countries have recently created a surge of investments into Real Estate across Canada. Over the last 4 years, the number of foreign buyers has exploded, as many foreign buyers have used the opportunity to park their wealth overseas in the safety of Canadian property. Though Canada needs foreign investment as part of its growth strategy, this surge of foreign investment has made the market more susceptible to fraudulent activities – particularly money laundering practices.
Increase in Speculation
As the Canadian Real Estate landscape drew in an influx of foreign buyers, and mortgages were made more readily available, many unsophisticated participants entered the market in order to chase profits. Housing starts boomed, multiple offer situations and bidding wars ensued, and contract assignments were occurring at an accelerated pace. So much so, in fact, that it gave rise to an unethical practice termed “shadow flipping”, a scenario whereby a seller sells his property to a buyer – who then re-assigns the contract (or “flips”) to another buyer for a higher price, prior to the closing of the sale and unbeknownst to the original seller. Backlogged building applications and development applications had city departments scrambling. Multi-family project developments began springing up everywhere, with construction labour costs and building material costs skyrocketing. During this boom, many of the unsophisticated participants found themselves over-leveraged in order to afford the purchase of the next speculation property.
Debt Servicing & Income Stagnation
As property values continued to peak, affordability began to come in to question. Values were increasing by double-digit percentages, yet the average income of the buyer remained stagnant. There has been very little increase in the incomes of the average Canadian home buyer. This red flag triggered the Canadian government to take action and install a “Stress Test” rule for Lenders to adhere to when underwriting mortgages. Out of concern over affordability, the government changed the rate at which the borrower qualifies for a mortgage – making it much more difficult to get approved. We are now seeing the impact that this rule (B-20) is having, contributing to a sharp decline of mortgage approvals in Canada. With this regulatory injunction, the overall number of buyers has dropped considerably and the Real Estate market has started to cool somewhat.
Bankruptcies, Foreclosures, and Unfinished Developments
Canada is arguably in the 3rd Phase of the Real Estate Cycle. Hyper-supply indicators are being found largely surrounding the aforementioned hotspot regions. Many “spec homes” are being sold at large discounts due to them sitting on the market for longer than expected, accumulating further interest and carrying costs. Developers who have run short of funds to complete projects on time, are seeing an enormous amount of overrun costs being added to their depleting budgets. Canadian household debt is at an all-time high, and Debt Management companies are reporting increased bankruptcy activity. To make matters seemingly worse, interest rates are expected to be on the rise this year, with the Bank of Canada suggesting to prepare for two rate hikes in 2019.
In understanding the implications of these factors, it would appear that we are either in or heading into a cycle of the Real Estate market where there should be considerable cooling and correcting ahead. What makes predicting this apparent bubble most complicated is the presence of fraudulent activity, money laundering, mass speculation, competing political agendas, and regulatory intervention. With an election year ahead, Canadians could see the natural process of the Real Estate market held politically hostage.