Juggling Dynamite

As interest rates fell from 1980 to 2020, the average Canadian home price increased 746% from $67k to $566k, while the median household income rose about half that rate (400%) from $21,252 in 1980 to $84,000 by 2020 (table courtesy of Nerd Wallet).

The average Canadian home price rose from about 3x the median household income in 1980-2000 to nearly 7x by 2020. Then, pandemic-era policies and frenzied behaviours drove the average Canadian home sale price up a further 44% to $816,712 by February 2022 (nearly 10x the median household income).

As interest rates leapt between 2022 and 2023, the monthly mortgage principal and interest payment on the average-priced Canadian home (with 20% equity or downpayment) rose 87% from $1,910 a month in June 2019 to $3,571 a month by June 2024 (courtesy of Jon Flynn Real Estate).

The Bank of Canada publishes a measure of home affordability in Canada—an estimate of how much disposable income is required to meet housing-related expenses (of which the mortgage is the most significant component). As of September 2023, in the country’s largest population centers, the number was an impossible 98 percent for Vancouver and 80 percent for Toronto.

A recent working paper from the Bank of Canada, Housing Affordability and Parental Income Support, finds that parental support, such as downpayment assistance and co-signing on mortgages, enabled young people to pay about 37% more for homes than they could afford on their own. The road to financial hell was paved with good intentions.

Across Canadian cities, mortgage debt per mortgagor doubled between 1999 and 2019, with the highest debt levels in the most expensive cities. Canadian household debt levels surpassed 180% of disposable income–the highest of the G7 nations.

Many bought or refinanced properties to extract cash for themselves and loved ones when prices were near all-time highs and interest rates near all-time lows. Policymakers and central bankers did everything they could to encourage the frenzy. A good deal of those choices are regrettable now.

About 13% of first-time home buyers (FTHB) had parents co-sign on their mortgages. About one-third of the parent co-signors still had mortgages or Home Equity Lines of Credit on their own homes. Now, debt delinquency rates and financial stress are rising for all parties.

Monthly payments for FTHBs towards housing and other debt take up about 70% of their gross household income, and the Bank of Canada study concludes that “it is very likely that some co-signing parents are also providing ongoing income support for their adult children.”

This nightmare reminds me of prior studies that documented how parental “help” to adult children harms the child’s ability to be financially self-sustaining. (Read The Millionaire Next Door (1996) for more.)

Over 66 % of Canadian homeowners have mortgages today (just over 60% in America).

Considering all these factors, it is unsurprising that in June, the year-over-year growth in Canadian residential mortgages was the weakest since the 2001 recession, 23 years ago (courtesy of the latest CMHC report and chart source).

With higher interest rates and unemployment rising, refinancing is even harder for many struggling to meet obligations. Selling or handing keys back to lenders are becoming the only viable options.

Policymakers and economies face a similar challenge globally. After the 2008 meltdown,  short-term rates were intentionally suppressed to incentivize credit growth and consumption at the expense of savers and productivity-improving investments. Now, we are paying the longer-term costs of those short-term focused choices.

As debt and unaffordability weigh on spending and employment, excess capacity and supply increasingly weigh on inflated prices. Central banks have started easing, but changes take a couple of years to filter through the economy.

In the meantime, risk assets, including real estate and equities, typically decline while policymakers do everything possible to ease financial conditions. Historically, the harshest recessions and job loss cycles have been led by downturns in real estate. Word to the wise.

Vancouver’s real estate market is overrun with high-end condos partly due to the collapse of China’s housing market and a lack of foreign investors looking to buy in Canada because of additional taxes on investment properties. Here is a direct video link.

Building hundreds of thousands of homes annually is one of Ontario’s most pressing priorities, however, the construction industry has been in a slump – thanks to a perfect storm. Here is a direct video link.

And while long-always capital has been rotating out of big tech into financials this month, that trade’s likely to prove less defensive than many think. Losses in the banking system are yet to be accounted for as lenders move through the messy and expensive process of eviction, collection and write-offs. See Here’s how Canadians could walk away from their homes if house prices fall:

While mortgage rules in Canada differ by province, all are full recourse with the sole exceptions being Alberta and Saskatchewan in situations where borrowers have not purchased mortgage default insurance (such as from CMHC). Where full recourse rules apply across Canada, lenders are entitled to pursue mortgage shortfalls in civil court under normal lawsuit provisions. So lenders file a statement of claim against a delinquent borrower, obtain a judgment, and then get an execution order to enforce the judgement to recover their losses. Case closed, lender made as whole as possible.

David Rosenberg, founder and president at Rosenberg Research, and Ed Devlin, founder of Devlin Capital, senior fellow at C.D. Howe Institute. and former head of Canadian portfolio management at PIMCO, join BNN Bloomberg to share their outlook on the economy and the markets. Here is a direct video link.