The Bank of Canada (BoC) head recently dismissed the need to cool real estate prices. Governor Tiff Macklem seems like he doesn’t want to say anything controversial… or he’s one of those people that thinks real estate prices only go up. That wasn’t the case back in 2013, when he served in the central bank’s number two role.
During his tenure as deputy governor, he warned about Canada’s addiction to real estate. In a 2013 speech, Macklem ripped on everything from overvaluation to GDP concentration. So what changed? Did things improve, or has ignoring the problem for almost a decade produced a situation too fragile to touch? Has everyone in charge just decided they don’t want to be the pin that pops the bubble? Let’s dive into his concerns back then, and how those indicators look today.
Canadian Real Estate Showed Signs of “Overvaluation”
In his former role, Governor Macklem felt home prices were overvalued. “Over the past decade, the price of the average home has risen from 3.5 times disposable income to more than 5 times.” Adding, “Housing activity in Canada is at a near record share of GDP, and there are indications of overbuilding and overvaluation in some segments of the housing market.”
Let’s quickly unpack how those indicators look today. The average home price was a concern to him at 5x disposable income in 2013. Today that number is over 15x, and that’s just at the national level. In Toronto and Vancouver, it’s much higher. Somehow, tripling a level of “overvaluation” is just a slight sign of overheating.
Another concern is housing represented way too large a share of GDP. That didn’t get better, it got much worse. Residential investment was around 6.5% of GDP in 2013, when he expressed his concern. In Q3 2020, residential investment jumped to almost 9.5% of GDP, meaning it consumes 46% more of the economy today.
In 2013, it was concerning to approach a record high. Today it’s “good for the economy” that it smashed the record? Canada’s residential investment as a share of GDP is now so high, it can’t see the US housing bubble without a telescope.
Investors Driving The Real Estate Market Made It Vulnerable
In the same speech, Macklem also said prices were being driven by investors creating speculative demand. “The total number of housing units under construction is now well above its average relative to population… there is also abundant anecdotal evidence that building has been spurred by investor demand, and is therefore more susceptible to changes in buyer sentiment.”
Canadian real estate was barely on the map of speculators at that time. It’s currently one of the most sought after markets for investment. In 2018, almost half of Toronto real estate investors bought negative cap condos.
Negative caps are when the market rent a tenant pays, is lower than the carrying costs of the unit. Every month the owner tops up the costs, with the hope prices rise more to make up the difference. Currently, rents are falling across the country as home prices are rising. This would likely mean the investment situation is even worse today. It also probably extends much further out of Toronto as well.
Household Indebtedness Was A Top Concern
High levels of household debt were a top concern. “Household indebtedness is elevated and a range of indicators suggest that some segments of the housing market exhibit stretched valuations and overbuilding… In the last 10 years, the pace of household debt accumulation has been unusually rapid. Household debt relative to disposable income increased about three times faster in the last 10 years than in the previous decade.”
The rate of mortgage credit growth has been larger, but it’s much higher than when he was concerned. The annual rate of growth in January 2013, when he made this speech, was 5.12% for mortgage credit. The last reported numbers in January 2021 show annual growth at 7.19%, a rate that’s a touch over 40% higher. I guess it was bad credit then, but it’s good credit now.
Canada Didn’t Dodge The Great Recession, It’s A Different Market
One of the most important parts of that speech wasn’t about housing, but reminding people Canada is not the US. Not how most people would guess either. Macklem emphasized Canada can’t take credit for dodging the Great Recession, because “we had our crises earlier. In the 1970s, we lost our monetary anchor, and suffered the harmful consequences of high and variable inflation. In the mid-1980s, two Canadian banks failed and two more were saved only by merging with larger institutions. In the mid-1990s, contagion from the Mexican peso crisis caused foreign investors to wake up to Canada’s precarious fiscal situation, and we suffered our own sovereign debt crisis.”
Before adding, “Where we can take credit is that we learned from our mistakes. In the aftermath of each of these crises, we put in place sound policy frameworks.” Housing is obviously something excluded from the mistakes we learn from, and developing sound policy frameworks.
Did the outlook improve? No, things actually got much worse over time. The dependence of the country’s economy on housing became even deeper. Politicians and bureaucrats took the easy path, and kicked the can down the road.
What would happen if he repeated even half the points of his 2013 speech today? It’s better to just shut up, and say we need the growth. It’s easier to wait until this turns into a systemic crisis, and claim no one saw this coming. Except for that time in 2013, when he literally warned everyone this was coming.
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