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Canadian Housing-Bubble Chart Book

Canadian Housing-Bubble Chart Book

By Pacifica Partners

Canadian real estate bulls have continued to cite the fact that real estate valuations have appeared "expensive" for years, yet, the momentum has continued to take prices higher. Real estate bears, on the other hand, claim that home prices have been so stretched from fundamental valuations that past price momentum is irrelevant.  As with all asset classes, a change to investor sentiment regardless of the catalyst that triggers the change (eg. rising interest rates, government policy, extreme valuations, etc.) will dictate future real estate returns.

To attempt to monitor real estate sentiment analytically, we examine the number of Google searches for the term "housing bubble" summarized by the originating city of the searches.  The table below displays the top ten cities globally in which the term "housing bubble" was searched in each year from 2004 to 2012. The highest number of city-sourced searches for "housing bubble" arise from Canadian cities, namely Vancouver, Toronto, Calgary and Edmonton.  The progression of the trend is ominous as California cities dominated much of the top searches until 2009, after which Canadian and Australian cities began to emerge.  Currently, four of the five cities that dominate global searches of "housing bubble" are Canadian, specifically: Vancouver, Toronto, Calgary, and Edmonton.

Check report at Pacifica Partners

Report Summary:

We continue to believe that Canadian real-estate is an asset class with an asymmetric risk profile. Simply put, the upside price potential to real estate is limited due to already extreme valuations yet the downside risks are significant from a number of factors including:

  • Policy changes involving the tightening of credit availability to Canadian consumers.
  • Rising interest rates as the Bank of Canada ends its period of emergency rates implemented since the financial crisis.
  • Over-supplied housing inventories.
  • Reversion to the mean of long term fundamental economic relationships eg: price to rent ratios, price to income, present value of cash flows from rental properties, home price appreciation relative to income growth, home price appreciation relative to GDP growth, etc. 
  • Broad economic consumer woes resulting from stubbornly high unemployment, weak income growth, and higher-than-targeted inflation.

Although housing prices are impacted by a number of economic and demographic factors, we believe that the prevailing themes stimulating Canada's housing market over the last decade have been twofold: Firstly, the organic growth of the Canadian economy in response to global demand for commodities has resulted in wealth accumulation and economic growth which can justify a component of house price appreciation. Secondly, over the last decade, there has been a rapid increase in Canadian mortgage and household debt which served to inflate housing prices through financial leverage. Both of these two factors, one sustainable but subject to contraction risks (GDP growth) and the other unsustainable for the long term (enhanced leverage), have merged into the almost unprecedented housing bull market.

Our outlook on Canadian real-estate remains negative and we believe Canadian housing will begin an extended contraction phase resulting in a move of home prices back towards long term sustainable valuations.