Break out the champagne for the next open house, because it’s all clear sailing from here. That’s according to the CEO of one of Canada’s largest real estate developers, who declared Canadian real estate achieved a soft landing. The situation is not unlike the US being declared a soft landing in 2006, but just like then – it’s way too early to tell. Here’s what you need for a soft landing, and why Canadian real estate markets aren’t even close at this point.
A soft landing is when a period of high growth is followed by flat growth. No crash, no bust, and there’s probably a few unicorns roaming around. The theory was developed by an O.G. of economics Robert J Gordon, who authored a paper in 1983 on business cycles. He theorized central banks could use monetary controls to dampen the business cycle. There’s only been one instance of a true “soft landing” occurring. The year was 1994, when Alan Greenspan managed to raise rates by 3 points without a recession. His second attempt at a soft-landing resulted in the popping of the dot-com bubble.
The soft landing has been achieved once with an economy, but never for a real estate market. Wealth manager Hilliard Macbeth, who literally wrote the book on Canadian housing bubbles, hasn’t been able to find a single instance of a soft landing in Canada. Heck, he hasn’t been able to find a soft landing in any major market that has experienced an exhaustion move. He explains “what people are calling a soft landing is really a pause and then a continuation of the bubble.” Before adding, “[that] means affordability gets worse and that means a hard landing is even more likely.”
Let’s suspend all logic, and take a trip down the same path that everyone selling a home or mortgage takes. We’ll assume a soft landing for real estate is possible. Unfortunately, even if we believe that, it’s too soon to be able to determine if we’re going to have a soft landing, nevermind if we’ve already achieved one. You see, a soft landing doesn’t just imply flat prices. It also means interest rates have peaked and will be flat, time has passed, and mortgage credit resumes growth. Let’s see how that looks right now.
Interest Rates Aren’t Even Close To Stable
Interest rates need to rise to neutral, and s**t needs to not fall apart. The Bank of Canada estimates the full impact of an interest rate adjustment takes 6 to 12 months to hit the market. The most recent hike was in October, which means we will experience the full impact in April at the earliest. That’s not even factoring that we haven’t reached the neutral rate, which is around ~42% higher than where we are now. We have a long way to go before the impact of rising interest rates has topped out. Heck, we have a long way to go for rates to no longer need to provide stimulus.
Bank of Canada Target Rate
The overnight rate set by the Bank of Canada .
Source: Bank of Canada, Better Dwelling.
Not Enough Time Has Passed
Toronto real estate has had three significant downcycles, and they lasted longer than a few weeks. The first one started in 1959, bottoming out 5 years later in 1964. The second started in 1974, bottoming out 11 years later in 1985. The third, which your parents probably have a vague memory of, started in 1989, bottoming out in 7 years. People that are good with math, likely realized the median Toronto correction lasted 7 years. After they bottom, even more time passes before we see prices recover.
Toronto Average Real Estate Sale Price (2018 Dollars)
The average sale price of a home through the MLS, adjusted to 2018 dollars.
Source: TREB, Bank of Canada, Better Dwelling.
The major reason it takes so long is the gap between incomes and home prices needs to come closer. As Hilliard explained, “a soft landing implies house prices level off and wages grow faster than inflation for long enough to close the gap.” Adding, “that won’t work because there will be a recession before that process can be completed.”
Real Mortgage Credit Growth Is STILL Falling
Once a soft landing has been achieved, we see growth resume. That certainly isn’t happening for mortgage credit growth. The annual pace of growth for real outstanding mortgage credit is up just 0.93% in October, the lowest it’s been since 2001. During that period, it was only this low for four months. The decline into those four months also occurred while interest rates were being aggressively slashed. Unless we get a whole lot of interest rate cuts in the next 6 months, we’re on the path to negative mortgage credit growth.
Real Canadian Mortgage Credit Growth
The annualized pace of mortgage credit growth at large Canadian lenders, adjusted for inflation.
Source: Bank of Canada, Better Dwelling.
Yes, I’m glossing over how serious this is, but I did explain why it’s likely to cause a once-in-a-generation type recession in Maclean’s this week.
Declaring a soft landing right now isn’t just rich, it’s wrong. Right now we have a broken altimeter, and can’t even see the landing strip. It’s actually fairly common for experts to declare a “new normal” after a break in declining prices. It’s actually so common, it’s a stage in the textbook chart for asset bubbles.
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