Canadian Real Estate Is Now A Bubble On Top of A Bubble: US Federal Reserve

Either the Canadian real estate bubble is now a bubble on a bubble, or old enough it should be in school. The US Federal Reserve (the Fed) released its quarterly exuberance index for Q1 2021. The index, used to determine country-level housing bubbles, shows Canada is well into one. The unusual circumstances make it unclear if it’s a long bubble, or a double bubble. It does show Canadian home prices have been in bubble territory for 6 years without a correction.

Home Price Exuberance and Emotional Home Buyers

The Exuberance Index is a measure of buyer enthusiasm for higher prices. It measures the prices paid in contrast with fundamentals, looking for explosive dynamics. That’s how smart people say, buyers paying irrational amounts of money. Emotional premiums like this are not based on fundamentals. Consequently, the price of these homes is subject to how people feel. Emotions change faster than fundamentals, leaving markets more vulnerable to shock.

The Fed developed the indicator after the US Housing Bubble popped, and wreaked havoc. By looking for a “smoking gun” indicator to call bubbles, they can identify and address them early. This limits the damage that they might do to the economy.

They crunch the numbers, and make it straightforward for researchers to read. Two sets of numbers are given — a critical threshold value, and an exuberance index score. If the score rises above 95% of the critical threshold value, buyers are acting exuberantly. If the market stays in this territory for five or more consecutive quarters, the market is exuberant.

Exuberant markets are better known as bubbles. The Fed argues this will result in a correction at some point, but they obviously can’t pin down when. Policy and credit extensions are often designed to drag out a bubble. This can run for as long as the government can continue to create a larger bubble.

It’s generally not advised though, since bigger bubbles create more dangerous corrections. Extending them too long inevitably slows down the economy, causing its own event. If you think losing home equity is bad, imagine how bad things get when the economy is dependent on the bubble. On that note, let’s see where Canada is.

Canadian Real Estate Prices Are Based On Emotion, Not Reality

Canada just passed another fifth quarter of exuberance, after a microscopic break. Canadian housing once again became exuberant in Q1 2020. In Q4 2019, it took a brief break below the critical threshold value — just 0.01 points below it. Since then, the market has completed five consecutive quarters in the exuberant territory.

Canadian Real Estate Exuberance Index

The US Federal Reserve Exuberance Index for Canada, and critical value threshold. A market that is is above the threshold for 5 consecutive quarters is considered to be exuberant.

Source: US Federal Reserve, Better Dwelling.

The Fed’s exuberance reading for Canada hasn’t been this high since 2017. Back then, it was due to Toronto and Vancouver, and the infamous foreign buyer mini-bubble. This time the whole darn country is actually showing signs of exuberance. Though it’s important to recognize, the current trend follows 15 quarters of exuberance. One quarter isn’t enough to have corrected prices, and it only fell slightly below that value.

Canadian Real Estate Has Been In A 6 Year Bubble… Or It’s A Bubble On A Bubble

There are two ways to look at this, and it’s just a technical labeling issue. Falling just 0.01 points below the threshold is likely within a margin of error. A single quarter isn’t enough for a new trend either. Remember, it takes five quarters for the market to be considered exuberant in the first place. In this case, the bubble would now be 24 quarters old, or about 6 years. Happy 6th birthday, Canadian Real Estate Bubble!

If you accept the break as definitive proof the first bubble was over in 2019, it’s two bubbles. Canada had a 19 quarter-long bubble, which ended in Q4 2019. It was then followed by the current bubble, which started one quarter later. In other words, it’s a bubble on a bubble.

Ultimately a label doesn’t change all that much. The facts are, buyers showed exuberance in 2015. Early signs weren’t tamed in 2016, which would have been the ideal time to address it. So it turned into a full-blown bubble. Since then there’s been no correction in home prices for the past six years.

Policymakers can either let it correct, or delay the correction until later, and hope it’s the next guy’s problem. By doing this, they’re actively creating more risks for Canada’s economy. No one knows when the bubble is going to pop, but we do know one thing for sure. When it happens, whoever’s in charge will say, “no one saw this coming.”

Federal Reserve researchers will try not to snicker, I’m sure.

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  • Hannah Goodman 3 years ago

    lol. Try 15-20 years for Vancouver. Even the Bank of Canada used to say it was a bubble back in 2010.

    • Doomcouver 3 years ago

      Yeah Vancouver real estate has been overpriced ever since the dot-com crash. The lack of a material correction in 2008 helped to stoke these ridiculous valuations as well. Now investors have a “can’t lose” attitude, an extremely dangerous sentiment to have in a highly speculative asset like Vancouver real estate.

      • Scott MacKinnon 3 years ago

        According to the CRA’s report from 1996, Vancouver’s bubble is celebrating 25 years. 100 Quarters old!

      • Rand Passmore 3 years ago

        So when the turd finally hits the fan will it then be a good time to buy that first home? Or will greedy flippers and big money be ready to pounce so fast the window will open and close before you can get to your bank and get mortgage approval? Or will a dominal cascade of bursting bubbles sideline everyone as a lengthy recession or chaos ripples through everything? Anyone got any contingency plans to clean up a huge mess? Oh,and maybe throw in Environment disasters and a sick USA political arena where leaders can’t cooperate to mitigate the disasters. And maybe another Pandemic. Will there be nowhere to go and hide?

    • WF 3 years ago

      its a bubble on a bubble.

    • melissa 3 years ago

      check out recent global news article which points to one of the biggest drivers of the inflated bubble, illegal/dubious Asian purchases/investment. homes should not be a “commodity” for foreign interest making it near impossible for tax paying, economy supporting, family raising citizens to afford homes of their own in their own country.

  • Ian Brown 3 years ago

    Six years? Wonder what happened six years ago.

    • Charlie Lee 3 years ago

      Capital flight, then the government lowered interest rates so the capital flight crowd could liquidate without impacting the value of their holdings.

  • Ethan Wu 3 years ago

    The supply crowd needs to learn a shortage of supply is inherently a bubble. That doesn’t mean prices are efficient. It means people are paying a premium to own, rather than wait until more supply is created.

    Is that a good idea? No one knows. Sometimes it works out, sometimes it doesn’t. What I know is my home’s value is certainly not worth what they say it is. I don’t know if that means a correction is needed, or money will be devalued through artificial wage bolstering (creating non-productive inflation growth).

    Either way, there is no healthy solution, and it gets worse by the day.

  • Tom Wolfe 3 years ago

    Nothing like a volatile market to make the rich richer.

    A double-bubble popping would cause a significant drop in value when Canadians are most vulnerable. Highly indebted; insufficiently paid; possibly unemployed Canadians stand to lose everything to those who can buy it out from under them at distressed prices. Then the buyers will flip them around to each other until they reach or exceed pre-crash prices while more Canadians learn to live under bridges and in parks.

    I fear for those who have cranked their mortgage(s). The true value of $1M will become despairing clear to the once-had/newly-have-nots, who only make an average Canadian wage. The fall-out will be truly tragic.

    • Trader Jim 3 years ago

      The other option is we tax the young until they leave to pay for the property taxes older crowds can no longer afford, there’s no liquidity to sell, prices crash, and there’s no ability because foreign markets have attracted the talent.

      Take your pick. The only ones getting screwed are the middle and lower class people that don’t have options, and are limited to these borders.

    • alex 3 years ago

      Important to note, I think it was mentioned on this website before that if we see if a crash, it will likely drastically change buyer sentiment toward Canadian real estate and demand will likely not reach the levels they were at pre-crash for a very-very long time – after all, this is exuberance, not fundamentals .

      A large part of why we are here is because of a combination of herd mentality and firmly held belief amongst Canadians that real estate is a risk free asset similar to a treasury bond(lol). If we see significant downside, I doubt people will be rushing to leverage themselves 19:1 in real estate like they are today.

      • Tom Wolfe 3 years ago

        If the stock market is any example, it may go down but it always goes up – way up – way beyond fundamental valuations. What were once homes, are now a commodity.

        BD has also shone light upon money laundering and how a new house value is set by the highest comparable sold price. If that is allowed to continue house prices will continue to be limitless, because it is not linked to real value, it is only linked to paper value. Canada will crystalize as cesspool of dirty money and abandoned neighborhoods and the house investors won’t care as long as they can move their money.

        We are witnessing the destruction of Canada and its irreplaceable lifestyle.

        It makes this Tom Wolfe very sad, and he should be way too ironic for that.

        • Travis Hunter 3 years ago

          Because rapidly expanding companies that consume every service revenue and a 300 sqft condo are the same thing.

          I’ve always thought of my bungalow in Vancouver as being as innovative as Google.

    • Doomcouver 3 years ago

      Agreed, the wealthiest stand to make a huge amount of money in a correction. Asset bubbles that pop tend to over-correct, meaning you may be able to buy houses at well under intrinsic values if you have a fortune to spend. Add to that the inevitable contraction in lending and massive loss of jobs in real-estate related business, it means that only the wealthiest will be in a position to “buy the dip”.

      Re-inflation of the bubble isn’t a foregone conclusion though. House hoarding by the wealthy may or may not actually cause another mania. A significant contraction in the Canadian economy may lead to a spike in net migration out of Canada, resulting in a potential depressed demand for housing, and lack of supports for home price acceleration.

    • Paul 3 years ago

      This is what I see too.

      Couple that with the retired generation having a mortgage to pay for the first time in our history. It doesn’t look good. The damage spread beyond the current and the future and reached into equity that took 30+ years to build.

  • Zhiliang Xing 3 years ago

    Perfect example of what Warren Buffett said, “Bubble can last for a LONG time”

  • david 3 years ago

    Canadians should realize companies will refuse to pay a premium for workers in expensive cities. With work from home, companies know back office tasks can be done from anywhere in Canada or the world (my big company does that a lot).

    We are literally shooting a bullet in the foot.

  • Hgbvv 3 years ago

    Toronto and Vancouver are way over priced, they will see significant drops. But other cities are still manageable.

    • Axel McLion 3 years ago

      Other cities will drop (to a smaller degree) as Toronto and Vancouver do.

  • Smug Canadians 3 years ago

    Our home prices are so out-of-this-world that any immigrant planning to come here will start looking for better, more affordable digs. In other words, wealthy immigrants will soon realize the up side is gone in Cda for RE prices for some time; so why invest there if I have other options. I’m sure this is already happening.
    The other thing I laugh at is the house shortage argument (most often by the RE industry). We’ve been building at record pace over the last 5-10 years and many experts say there is more than enough production to satisfy the market. If we were to go crazy building tens of thousands of homes, they’ll just as quickly be swept up by individual and corporate speculators, leaving nothing but dust for the average folk.

  • Sandy 3 years ago

    Many people fail to realize or mention, this is not only happening in Canada, but every part of the world. Only in Canada we make a big deal out of it, homes are sooo overly priced in under developed/third world countries and even more expensive than Canada, their’s lands have all gone up and way wealthier than Canadians… people please research countries all over the world before crying about Canadian real estate.

    • Travis Hunter 3 years ago

      Not even close to true. You can buy a full detached house in the NYC city limits for less than one in Toronto. The difference is a bubble is a 4% price increase in a city with a GDP bigger than all of Canada.

      Canadians have become so delusional they think 4% and 60% are the same thing. THAT is the bubble. The inability to see what’s different from one country to the next. You can’t find cheap housing anywhere in Canada now.

    • Name it 3 years ago

      Sandy, which countries? A lot of countries in European Union have better and more affordable housing.

  • Dale LePage 3 years ago

    The Canadian Real Estate market will collapse into a crash of apocalyptic proportions. The housing bubble has been long overdue for a correction which will destroy the Canadian economy for years. The driving force behind the bubble is not exuberance but naked greed.

  • JCH 3 years ago

    While I agree that Canada’s housing bubble(s) are long overdue for bursting, I have given up on it happening within the next 10 years or so – I have long underestimated the determination of all levels of Canadian govt/BOC to prop up this bubble at all costs.
    I’ve been expecting a burst for 11 years now, and now know that a bubble can go on far longer than anyone believes is possible.
    So instead I’m making plans to leave Canada – I’ve given up on ever owning a home here.
    Canadian voters, demand that your politicians #lethomepricesfall !!

    • Happy Expat 3 years ago

      I agree with you. At one point I thought the bubble would burst, but I finally realized that our governments will never let that happen. That is why I left Canada at the beginning of September. Why stay in a country with such a bleak future? Low wages; high taxes; insane rent, house and food prices; unabated house hoarding; an unwillingness by our governments to deal with the narco economy and money laundering problems; allowing wealthy immigrants to claim refugee- level incomes while buying up multi-million dollar homes; shouldering the burden for all those millionaire/billionaire leeches who claim low/zero income and take advantage of our education, health care and government benefits & support programs — and the list goes on. I had enough of being a law-abiding, tax-paying, and responsible citizen and getting s*#$ on in return.

  • Jamush 3 years ago

    The wisest option is to be plan and prepare to leave Canada and move to another country to work and buy a home and have a family. We have to make our own way in life, do not count on anything else or any help or luck. Let’s go make our own good life – somewhere feasible.

    When it crashes here, the damage will be so strong and long lasting, that you may not even have a job or income at the end of the day to buy a cheaper home if it is ever cheaper. The government austerity, and a dollar in the range of 40-60 cents, will crush people for decades. Higher taxes will come to bail out the speculators and banks and so on. Everything you need will cost double with such a weak currency. The brain drain will start up again at that point and go on for decades.

    Raising kids in such a country will be depressing, more depressing than it has been to grow up in Canada and enter the job market during austerity/financial crisis, see high unemployment and under employment with mass immigration and massive home price/rent inflation, and now Covid and high unemployment with even more mass immigration proposed by the government. Who would want to raise kids in a country like that?

    If you can, get out now, and move your money and assets abroad before that happens. Certainly everyone needs to minimize CAD holdings and overly Canadian/domestic exposed assets.

  • Rahim K 3 years ago

    The biggest exposure to the Canadian real estate markets is interest rates. Unlike the US mortgage market where you can get a 30-yr fixed rate mortgage (basically interest rate remains the same for 30 yrs). Canadian fixed mortgages are actually only fixed for 5 years. That means your rate can go up or down during your next renewal in 5 yrs of a 25 or 30yr amortization period. Now Canada does offer 10 yr lock in periods but that’s not a common mortgage rate that Canadians entertain.

    The fundamental driver for all these asset bubbles (including valuation of certain growth stocks) is the low interest rates. Specifically long-term bond yields. For 3 reasons:

    1. The return on fixed Income asset classes is so minuscule that investors are prepared to risk their wealth in other asset classes like stocks and real estate.
    2. The cost of money is cheap with interest rates so low, people are willing not just to take the risk but to take it at a very low cost of borrowing that money from the bank.
    3. Discounted cash flow with rates so low, project a much higher present value especially when you incorporate the future value based on the YOY price growths we’ve been seeing in the Canadian Real Estate market.

    As we emerge from this COVID crisis and the Central Banks and Federal Reserve start slowing down to eliminating the QE (Bond & MBS purchases) measures over the next 6-8 months, we’re going to start seeing bond yields rise again and investors will start to rebalance their asset allocations.

    The catastrophe could likely occur if the Central Banks and Fed are wrong about their assumptions that inflation is transitory. If inflation is not transitory and is here to stay, the tool the Central Banks & Fed will need to use to combat inflation is increasing interest rates. This means, those Canadian fixed rate mortgages renewing in 5 years would be exposed along with all the variable rate mortgages.

    This is the primary reason Government has demanded lenders in Canada implement the stress tests to ensure that home owners taking out new mortgages or refinancing are able to make payments against a certain hurdle rate vs. the current market rate.

    I read an earlier comment where someone suggested the bubble commenced in 2008 during the Great Recession.. That sounds about right because I remember having a mortgage rate in 2007 of around 5% and because of the 2008 collapse in the economy, central banks and the Fed brought their rates significantly down or in some cases had to put it in negative territory and mortgage rates dropped accordingly.

    Bottom line… do we now expect inflation to remain, some say signs are evident that inflation is here to stay considering once the cost of labor is up, it doesn’t typically come down not in a growing economy. So count on interest rates going up but whether we have considerable increases to impact real estate valuations significantly is to be seen,

    Regardless the market and the economy is cyclical and things will change they cannot keep going up not at least at the rates we’ve been seeing in the last few years.

  • M.Bury 3 years ago

    The real estate industry has a neat little scam going…they’ve managed to convince people to buy first, sell later. It assures there are always more buyers than sellers.

  • Rick 3 years ago

    According to the chart, the critical value isn’t all that important. What’s important and therefore with predictive value is the having and staying at the peak value. As with the stock market, you can’t see the peak until it’s past it.

    If the peaks of 2002 – 2007 are any indication, it looks like the Canadian market still has a couple more years to rise until the value hits at least 4 – 5 range.

    In fact, the red critical value line seems to have formed a “support” at 2016, 2020, and the whole index is that of a “rising” shape, indicating a continuing bull market, if it’s anything like a stock market. If the chart is trying to indicate the presence of a bubble due to crashing down, it’s showing the exact opposite.

    • Gerry 3 years ago

      according to that chart, the researchers don’t know what they’re talking about.
      — everyone in a bubble

      Canada had sharp corrections in 2007. Toronto didn’t correct because it wasn’t back at its real adjusted 1990 value.

      The difference between a market bubble and a credit-driven bubble. This is a credit-driven bubble, which means it doesn’t matter where the house is, it’s making huge gains.

      • Rick 3 years ago

        My regret is that I didn’t (well, couldn’t any ways) buy 10 houses back in 2008. Would’ve had a hellava payday now.

        Did meet someone who did buy 7-8 houses in 2009. Looking back, what a great foresight and courage to ignore all the doomsday naysayers.

        In my opinion, a good indicator for a real market crash is when everyone, including commentators and media, are saying the value of the asset will rise indefinitely / $x (a very high value). That was the case for the 2007 gold bubble when everyone was saying gold will reach $2000 and ounce or more (astronomical back then).

        Based on the above, the housing will still probably grow for a while.

  • Amos Ashurst 3 years ago

    People have been saying that Vancouver RE has been in a bubble for close to 20 years. Doesn’t mean we’re not now in a bubble, but it does make me skeptical of this conclusion (since bubbles presumably don’t take 20 years to pop)

    Also, super high asset values (stocks, bonds, RE) are arguably rational in a negative interest rate environment.

    • Ben 3 years ago

      I bought my house in 2015 in Vancouver, and it was actually quite affordable. Our household salary is almost double now, and we couldn’t afford the same home if we bought today.

      Just because it wasn’t affordable to you, doesn’t mean it was an unaffordable market. The CMHC overvaluation model even shows it’s less of a bubble than Toronto, because we have more high income households.

      Now only 1-2% of people can buy a non-condo home in Vancouver. That’s not enough for a market to be liquid.

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