The Canadian Property Bubble Reaches Contagion, Making A Financial Crisis Likely

Prices just outside of frothy Canadian real estate markets are growing much faster than in the city. That’s typical of a bubble, and it’s called “housing bubble contagion.” In a paper titled Housing Bubble Contagion From City Centre To Suburbs, three Taiwan-based researchers argue bubbles spread outwards. Bubbles force investors and developers to look for “deals” outside of the city, sending prices soaring. The result is a larger bubble, with suburban prices being much more frothy. Looking at Canadian real estate data, that’s exactly what’s happening in Canada.

Housing Bubble Contagion

Home prices diffuse from a central hub or major city, to the surrounding areas. That’s well established. It wasn’t until 2017 that these researchers discovered bubbles follow the same path. It’s often mistaken as a spread of fundamentals. 

When this happens, it’s called a “bubble contagion.” Not unlike a virus, the host is infecting those with close contact. The issue is passed from person to person, but instead of getting sick, they think a teardown bungalow is worth two million.

It actually makes a lot of sense, considering the psychology of a bubble. Prof Jean-Paul Rodrigue infamously broke down the bubble mindset into four phases: 

  • stealth, when smart money begins to accumulate a position, and place big bets;
  • awareness, where institutional investors start to see opportunity;
  • the mania, when prices start to really take off after the public jumps in, and smart money begins to rotate out; and
  • the blow off, where people are terrified to touch the asset, after watching everyone lose a whack of money in the decision.

The bubble contagion theory puts a unique spin on real estate bubbles. Unlike a stock, the public can’t just buy a few shares for further exposure to the market. Instead, they usually need to buy a whole home, or pool with other investors. When prices rise to, oh, I don’t know, the point where only 5% of the population can buy, those that want to speculate, can’t. 

Main Stages of An Asset Bubble

The result is aspiring investors, and the real estate developers who love them, look to the burbs. The researchers observed bubble behavior moving from the City Centre of New Taipei to the suburbs. An influx of money tends to produce an even bigger bubble than had been contained to just the city. The suburban bubble often sees a bigger gap between the price and funamdentals.

Canadian Real Estate Prices Are In A Bubble

Canadian real estate is in a bubble, and that’s not just my opinion — it’s the opinion of finance authorities. Not professionals, authorities. The US Federal Reserve has Canadian real estate in its 19th consecutive bubble quarter. Bank of Canada (BoC) also created a similar model, but said bubbles were limited to Toronto, Hamilton, and Montreal.

The IMF also estimates some cities need big drops to reach fundamentals: Toronto (28%), Vancouver (15%), and Hamilton (29.6%). So let’s skip the debate, and accept that the bubble is as real as government incompetence..

Housing Bubble Contagion Is Spreading Across Canada

BoC research also shows the housing bubble contagion is already spreading. They just won’t acknowledge it. They found Toronto homes located within one kilometer of the city center saw annual price growth fall 1.9% in the fourth quarter of 2020. Once you get 30km out, double-digit annual price growth becomes normal. When you hit 64 km, prices were making 19% annual growth. Toronto now has banks warning, make sure you really want that surban property, because you may be stuck with it.

Toronto Real Estate Prices From City Center

The annual percent change in Toronto home prices, by the distance from the city center.
Source: BoC; Teranet; Better Dwelling.

Similarly in Vancouver, home prices are rising much faster outside of the city as well. Within one kilometer of the city center, annual home price growth fell 1.3 percent in the fourth quarter of 2020. Between 40 and 60 kilometers from the city center, growth is consistently above the baseline trend.

Vancouver Real Estate Prices From City Center

The annual percent change in Vancouver home prices, by the distance from the city center.
Source: BoC; Teranet; Better Dwelling.

Home Buyers Flee To The Suburbs For “More Space” In Every Bubble

The pandemic changed buying habits though, so this time it’s different — right? Maybe, but maybe not. The researchers said, “… abnormal demand shock qualifies as a bubble.” In other words, it doesn’t matter if people all of a sudden really, really want to buy a home because of low rates. An increase in price that’s abrupt and not ground in a change in local market fundamentals isn’t a rational price movement. Ditto with, “I had to pay 20% over ask because 72 people also bid.” It’s not a bubble if one person does it. It’s a bubble if everyone thinks what that person did was normal.

Besides, the suburban “this time’s different” narrative has popped up many times before. In Toronto’s late 80s/early 90s bubble, a Globe and Mail article titled Toronto’s Growth Moves Away From The Core (15 May 1989) was published. The journalist mentioned people were fleeing the city, due to the “high rents, traffic congestion, and restricted development of downtown Toronto.” Then prices went up forever, and people stopped moving to Toronto because it just kept getting less affordable. Kidding. Prices cratered and values didn’t recover until the 2010s in real terms.

In the early 1980s bubble, a piece titled Bigger, Better Home Seen As Family Refuge During Tough Times appeared in the Toronto Star. In it the author said global catastrophes have people seeking out larger homes in the suburbs. More family time and outdoor space were of sudden interest.

These aren’t new issues. It’s the same justification surrounding the same frothy behavior people demonstrate. People aren’t robots, they’re irrational. They do irrational things. They are hardwired to justify those things though.

Canada Is Doing Literally The Opposite Of What They Should Do To Stop Bubble Contagion

Not unlike any other contagion, nipping a bubble in the bud, as quickly as possible is the best solution. The researchers found if a city becomes exuberant, suppressing market activity limits the damage. In the event it spreads to the suburbs, it becomes more problematic. It increases the chance shock will be felt.

“To prevent the financial crisis because of the housing bubble from bursting, the central bank should implement measures that are more stringent in suburbs such as raising the mortgage rate, implementing loan controls to reduce the money supply, and limiting the amount for construction loans,” say the researchers.

Canada recently loosened measures, lowered mortgage rates beyond market rates using QE, expanded the money supply rapidly, and is providing construction loans. If Canada has any real estate bubbles, it’s literally doing the exact opposite of what it should be doing to prevent a financial crisis.

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  • $20million - no condos 3 years ago

    I bought a house originally listed for 380k in 1992 for mid200k the next year. Recently sold it for 11 times that ‘cause I thought that it couldn’t go any higher. Traded it all for massive land (100s of acres) near Canada’s 4th largest city. I need 20 years of remote work and I hope to sell it for 11x more again or prolly just give it to my kids.

    • D 3 years ago

      Canadian land is practically worthless unless there’s some oil or metals under it.

      • Betty Shacter 3 years ago

        From what I read in the article, it makes logic for homebuyers who are searching outside the city, I agree, banks need to increase the mortgage rates in the suburban areas. As a renter, the cost of a dwelling is $2500 and up in the suburban area, since the pandemic my hours have been cut back. It’s impossible to find something affordable, so I was forced to look further out even from the suburban area because, now it’s a landlord market and the requirements the landlords are requesting is so invasive. It makes it impossible to find affordable housing now or you are placed on a waiting list. Homeowners are now splitting their homes into duplexes and asking for the main level $1850 and up. It’s doubling, and the Homeowners mortgage is being paid my renters twice in a month. It’s unbelievable that myself can’t afford to live in suburban area, and forced to look into small town living.

  • simon 3 years ago

    good article!

  • Ahmed 3 years ago

    You need to be drinking a lot of kool aid to think a 50% price increase in cottage country is “fundamentals.”

    • Christopher Barclay 3 years ago

      The concept of fundamental home prices is mostly just BS. As if every market is worth a third of income, regardless of where it’s located. How much does an extra person added to market introduce, vs a net loss of population?

  • Rick Abrams 3 years ago

    When I look at how people behave when it comes to land values, I pray that Darwin was wrong or else we’re doomed.

  • Jim 3 years ago

    What happens to the Loonie? Will it test 60 cent levels like in 2002?

    • Christopher Barclay 3 years ago

      The US will have to raise. Canada is most likely holding low rates much longer than it wants to because it’s trying not to become too strong. The whole country’s value prop is foreign companies can buy stuff and employ people for cheap.

  • jim 3 years ago

    It’s a “perpetual economy”, like “perpetual motion”, it’s not hinged to reality, just to real estate.

  • WS 3 years ago

    “Toronto (28%), Vancouver (15%), and Hamilton (29.6%).”

    Vancouver 15% ???????????????
    How can we take this seriously?

  • Steve K 3 years ago

    Just learn to think like a politician or banker:
    “The bubble can’t pop if we import 500 thousand new people a year into the country!”

    • Harjot 3 years ago

      It’s 400,000 per year and I agree. I contacted my MP and they keep pointing to programs to boost affordable housing construction. Which doesn’t mean anything because new houses keep getting allotted to investors. People are owning over 10 houses. I will vote NDP next election because they are the only ones looking out for the public and not big business.

  • Ghl 3 years ago

    Well, here are some facts. If you have a house with big lot and nice private backyard near city center. That value can only go up because they will never have those big lots at that location anymore.

    • loyd 3 years ago

      That may work as long as city downtown does not become abandoned. If city becomes too socially toxic, everyone moves to burbs and downtown may become abandoned. Most notorious example Detroit. In Canada, good example is Niagara Falls, the downtown area is the cheapest part of the city, most RE value is in Chipawa, West and North ends and numerous efforts to revitalize the downtown failed.

  • Pete 3 years ago

    This article is about that we passed mania and reaching delusional state.

  • Investor 3 years ago

    We’ve seen this party before. Everyone forgets easily and prices move to another level in a year or two. The government, banks, speculators, FOMO actors, e.t.c cannot perpetually support a market devoid of fundamentals. Someday, everyone will receive a rude awakening and it will be sudden. This market isn’t going to crash when everyone is crying wolf or talking about the heaven falling. It’s going to cometh like a thief in the middle of the night (I love that phrase😀).

  • Allie 3 years ago

    This article has it wrong..housing prices follow the stock market..a recession will cause a devaluation, not the other way around. The “bubble” is a myth, in my opinion, we can’t build new houses fast enough to supply 1% population growth annually via immigration alone, nevermind demand by another generation of our own kids. And there just isn’t enough land around the major centers to satisfy demand, can’t build with rivers, mountains, lakes and international borders in the way. Houses in these markets will always hold their value.

    • Trader Jim 3 years ago

      Said someone that clearly doesn’t realize Canada’s stock market was abysmal over the past two years, while the housing market increased. Now that the housing market is slowing, the stock market is growing.

      You can’t look at US stocks, and then say it’s a leading indicator for Canadian housing.

  • Kevin 3 years ago

    Good points! I’m just an irrational human that always believes he’s thinking rationally. I think there’s a serious supply issue in Toronto. Rent and home prices are insane! I don’t even know what a suburb is because Toronto suburbs all feel like cities by now. Cottage country prices are probably a bubble though. For the bubble to pop people will have to change their mindset from living with only their family to living on top of each other, 2 to 3 families per home for many years (which is already been happening). The new housing inventory being developed is getting smaller and smaller. Which will make it harder to have multiple families in a single-family home. Homelessness is another option for this bubble to pop. If these two things happen prices will stagnate. Canada will also have to cut back on immigration targets for the bubble to pop as well. Which I think is unlikely because it’s one of the primary ways we inject money into our economy.

    • Pete 3 years ago

      Delusional thinking Kevin…..

      Take a look at NYC, not much land around. However in 30-40 minutes commute time you can buy decent house in nice neighborhood for 500-700; income to shelter ratio is 3 to 4 times of GTA.

  • Pastaman 3 years ago

    Makes sense to me. Five years ago, a $60k salaried job would afford you a small condo within commuting distance in Toronto. These days, those same condos require an income of over $100k. 1bdrms that were once ~$300k in 2016 are now ~$500k.

    The issue is that most employers generally only increase wages by about 2% per year. Because of that, a lot of tech jobs in Toronto are only offering about $65k-$85k. It’s not easy to survive in Toronto these days with an income like that.

    This was eventually going to drive first time buyers out of the city. The pandemic was just a catalyst for this.

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