Canada’s oldest bank sees today’s real estate markets having a lot in common with the late 1980s bubble. In a research note to its financial markets customers, the Bank of Montreal (BMO) highlights the similar trajectory homes have made. A similar event that slowed home price growth during that period is approaching — higher interest rates. Once price growth slows, the bank sees people being “surprised” by how fast supply issues resolve.
Canadian Real Estate Prices Driven By Loose Policy For Too Long
Canadian real estate prices weren’t exactly performing poorly before the pandemic. There were several pressures, from money laundering to speculation, that sent prices soaring. Then the pandemic struck, and the cheapest mortgages in history added another layer.
Canada’s economy is nearly back to where it was pre-pandemic, and better in some areas. Still, the credit is nearly as cheap as it was during the worst part of the recession. Not surprisingly, this is fueling the fastest home price growth in history.
“We’re in the midst of getting January reports from the major Canadian real estate boards, and all indications are that the market today is as fevered as it has been through this whole pandemic episode,” said Robert Kavcic, a senior economist at BMO.
“It’s pretty clear that expectations of home price growth have been allowed to root for too long, aided by too-loose policy. Even OSFI is now warning about speculative activity in the market, which has long been confirmed by survey data, transaction-level data and our own eyes,” he adds.
The economist is referring to a podcast interview with OSFI head Peter Routledge. In it, the head of one of the world’s largest bank regulators called Canadian real estate a “speculative frenzy.” He wasn’t too optimistic about how it ends for homebuyers. However, he did explain the banks are more than ready for events like a housing crash.
Canadian Real Estate Resembles The ’80s Bubble
Canadian real estate investors often point to the nothing-burger in 2008. Despite a massive housing crash in the US, Canada was largely untouched. Most don’t realize this is due to the fact some cities like Toronto had not yet recovered from the 90s crash. In real terms, that only occurred around 2010. It’s not hard to understand why the Great Recession had a minimal impact in Canada. There is little to correct when home prices are still recovering from a crash a decade earlier.
Canada’s last major real estate crash was in the early 90s. BMO charted the indexed home price growth during that period, to show how similar growth has been. Then showed how those prices have moved since the start of each real estate bubble in years. “Note that the late-1980s is an infamous period in Canadian housing market history,” he says.
Ontario Average Real Estate Prices Compared To Late 80s Bubble
The average Ontario home price indexed and compared by years of growth. Index 100 = start of period.
Source: BMO Capital Markets.
“Real average house prices ballooned almost 100% in four years through 1989. The current trajectory (using January 2019 as the starting point) is keeping right on pace with that past episode, which ultimately ended at the hands of Bank of Canada tightening.”
Supply Issues Will Ease When Price Growth Does
Canada’s housing supply shortage is real, but the extent is greatly exaggerated. Especially when it’s used to justify this level of home price growth. “For the supply-side activists, the current psychology boosts demand while at the same time holding back listings,” he said.
Cities like Toronto are seeing home prices rise by the median annual income in a single month. If you own an extra house or two, and it’s making more than you do at work, you’re probably not going to sell it. Even if you’re thinking of cashing out and moving to a cheaper region, most would try to maximize their gains.
When price growth slows, the bank expects that to change. “Why sell today when you’ll get 10% more tomorrow? … When policy finally breaks this sentiment, you might be surprised how quickly the ‘lack of supply’ problem goes away,” says Kavcic.