Update on the Canadian Real Estate Bubble II
By Philippe BÃ©rubÃ© – Freebuck.com
â€œWhen the American economy sneezes, the Canadian economy catches a cold.â€
The old saying does not apply well to the current state of the US and Canadian real estate markets. The US real estate market has been in a downward spiral for several months, but the red hot Canuck real estate market is barely showing signs of slowdown.
From April 2006 to April 2007, the cost of new housing increase was of 8.9% in Canada. From March to April 2007, the same cost grew by 0.8%. Canadian housing starts grew at a seasonally adjusted annual rate of 9.2% from April to May 2007, up 4.9% year to year after a few months of decrease. CDN GDP is still growing at a 0.9% clip.
US housing starts fell 2.1% in May 2007, after rising by 1.0% in April 2007. The fall was the first since starts dropped 14% in January. Starts, year-to-year, were 24% lower than the May 2006 level. US sales of new one-family houses in April 2007 were up 16.2%, above the revised March 2007 rate, but 10.6% below April 2006 estimates. US GDP growth in Q1 2007 was revised down to an annual rate of 0.6%.
There is no doubt that we are currently doing better than our southern neighbours, but numerous factors could negatively impact on Canadian real estate in the coming months.
1) The Canadian dollar could reach parity with the US dollar before the end of 2007. Aside from giving another argument to those cheering for a single North American currency (I am not one of them), this rise is already hurting exports with our largest trading partner to the south in the form of a reduced trade surplus. We can seriously reduce our expectations for future balanced federal budgets if this trend continues and produces a recession in the US next fall. Canada may have already lost 250,000 good-paying manufacturing jobs in the past two years, due to this rise.
2) The Bank of Canada has announced that current economic growth and inflationary pressures could incite them to raise rates within the near future. Following this announcement, fixed-term mortgages grew by more than 0.5% and have now crossed the 7% mark (they were still under 5% about 15 months ago). This should hurt the national real estate market in the long term, as I suspect housing and rental affordability indexes will continue to deteriorate, while housing prices and interest rates will continue to go up for a while.
3) 40 year mortgages have been introduced to Canada in 2007. This encourages overly indebted Canadians to lower the monthly amount they pay for a house, but will make them poorer over their lifetime as the average total interest cost for a 40 year amortization is roughly 50% higher than a 25 year amortization, depending on future interest rates. This measure is sure to make private banks billions in additional profits.
My suggestion for younger homeowners is to get out of personal/student debt and then directly apply future savings to reducing the capital of your mortgage. There are usually limits to the percentage of capital you can repay on the loan per year, but a $1,000 lump sum payment applied early to the remaining principal of your mortgage can save you more than $25,000 in interest in the long run and will generally outweigh the penalty incurred for paying back this capital. I do not personally recommend borrowing a lump sum payment from a credit margin, but am aware that some have found this profitable.
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