The Pun­dits (like Garth Turner) Say: Cana­dian Real Estate Is A Bub­ble About To Burst!
Cliff Küle Says: “Per­haps, But Per­haps Not” (It’s Deflat­ing Already)

By Cliff Küle

In ancient China, there lived a poor, but wise, farmer. One day the farmer’s only horse broke out of the cor­ral and ran away. The farmer’s neigh­bors, all hear­ing the bad news, came to the farmer’s house to con­sole him. The neigh­bors all said, “Oh, what a mis­for­tune.” The farmer replied, “Per­haps, but per­haps not.”

About a week later, the horse returned, bring­ing with it a whole herd of wild horses, which the farmer and his son quickly cor­ralled. The neigh­bors, hear­ing of the cor­ralling of the horses, came to con­grat­u­late the farmer on his good for­tune. As they looked at the cor­ral filled with horses, the neigh­bors said, “Oh, what a bless­ing!” The farmer replied, “Per­haps, but per­haps not.”

A cou­ple of weeks later, the farmer’s son severely broke his leg when he was thrown from a horse he was try­ing to break. The neigh­bors all hear­ing the news, came to con­sole the farmer and son. The neigh­bors said, “Oh, what mis­for­tune.” The farmer replied, “Per­haps, but per­haps not.”

At that time in China, a war broke out between two rival war­lords. An army came to the vil­lage and con­scripted all the young men to fight in the war. The farmer’s son, with his bro­ken leg, was left behind, unfit for mil­i­tary ser­vice. The other young men of the vil­lage died in that war.

NEVER BE TOO CERTAIN

The price of Cana­dian real estate has held up remark­ably well since the crash that demol­ished real estate val­ues in the U.S. & around the world. Some basic, ordi­nary homes in Toronto and Van­cou­ver  are sell­ing for over $1,000,000.

It seems easy to claim that prices will crash in places where they did not crash. Try ‘Googling’ the words Cana­dian real estate bub­ble and you will see more than 4.9 mil­lion results. If that doesn’t seem out­ra­geous, con­sider it rel­a­tive to Canada’s small pop­u­la­tion. Con­sider that Canada’s Hous­ing Bub­ble is a sur­pris­ingly active web­site. Think about CBC head­lines like: “Be Very Afraid of the Cana­dian Hous­ing Bub­ble”. Think about the Globe & Mail (Canada’s major news­pa­per) head­lines like: “Real Estate Swoon Deepens”.

Garth Turner (Cana­dian author of invest­ment books, for­mer mem­ber of Par­lia­ment, for­mer Busi­ness Edi­tor of TV & news­pa­per) has been pound­ing the table on his blogsite, The Greater Fool. He says things like “There’s a 100% chance inter­est rates will be going up .. to deflate demand & val­ues and cre­ate that melt that I keep telling you will be…” He also says that six years into the U.S. real estate implo­sion, “it just gets worse. The lie of a nation is that Canada escaped. We won’t.”

It seems like the whole world is say­ing: ‘Cana­dian Real Estate is in a Bub­ble That Will Burst’. We say: ‘Per­haps, but per­haps not.’ We also say that a gen­eral con­sen­sus is gen­er­ally wrong, and ‘con­ven­tional wis­dom’ is an oxy­moron. Our point is that there may be forces at work that aren’t being seen.

Cana­di­ans Might Not Be See­ing ‘The Big Picture’

The real dri­ving force might not be in Canada. It may be global forces that are dri­ving Cana­dian real estate prices. Global eco­nomic forces are mas­sive rel­a­tive to Canada’s small pop­u­la­tion. Global per­cep­tions work on Canada in a highly lever­aged man­ner. The Cana­dian econ­omy is 1/10^th  the size of the U.S. When the world alters the per­cent which it chooses to invest in Canada (espe­cially as com­pared to the U.S.), it has far more ‘torque’. If the world nor­mally invests 1/10^th as much in Canada as it does in the U.S.,  then raises it to 1/5^th , the impact on Canada is a dou­bling, not a 10% increase.  The lever­age is explained by an old expres­sion. It has been said that when some Cana­dian invest­ment becomes the ‘dar­ling’ of U.S. investors, “it is like try­ing to get Nia­gara Falls to flow through a gar­den hose”.

We will focus here on the Cana­dian res­i­den­tial real estate, though much will also apply to com­mer­cial & farm­land real estate.

1. Canada is viewed as a safe haven in the global finan­cial cri­sis. In some sense, as the world’s finan­cial cri­sis gets worse, Canada’s attrac­tion increases. Much of the world per­ceives Canada as more fis­cally pru­dent, with safer banks, a more wel­com­ing atti­tude and busi­ness envi­ron­ment than other devel­oped nations (includ­ing the United States). Whether true or not, per­cep­tions are impor­tant. Money comes into Canada for invest­ments in the com­modi­ties sec­tor. Emerg­ing mar­kets need resources and Canada has them. Money is also com­ing to Canada for its cur­rency and gov­ern­ment bonds. Investors view the Cana­dian Dol­lar as a ‘commodity-based cur­rency’ at a time when there appears  to be a long-term, sec­u­lar com­modi­ties boom (albeit with seri­ous ‘hic­cups’).  For­eign investors have also put money into Cana­dian gov­ern­ment bonds; per­ceived as hav­ing less of a debt prob­lem than the U.S.. Demand for Cana­dian bonds is help­ing to keep inter­est rates low in Canada, which in turn, helps keep home prices buoyed.

2. Immi­grants are see­ing Canada as more attrac­tive than the United States. While the U.S. was a wel­com­ing nation gen­er­a­tions ago, recent his­tory seems xeno­pho­bic. Mid­dle East­ern­ers have had a hard time even  before 9/11. Fences, vig­i­lante bor­der guards & cam­paigns to remove Mex­i­can work­ers have an impact on atti­tudes around the world.

Pierre Trudeau (“that lib­eral pinko” accord­ing to the Nixon admin­is­tra­tion) encour­aged immi­grants to main­tain their dis­tinct com­mu­ni­ties and cul­ture. The pol­icy was referred to as a ‘Cana­dian Mosaic’. This was very dif­fer­ent than the U.S. ‘Melt­ing Pot’ model. Is it pos­si­ble that all these years later, the ‘Cana­dian Mosaic’ model is pay­ing div­i­dends to Canada; increas­ing immi­gra­tion and invest­ment?  While the U.S. seems to believe that for­eign­ers are tak­ing jobs away from Amer­i­cans & tak­ing government-provided social ser­vices, Canada has done stud­ies that show immi­grants to be a pos­i­tive force. They tend to accept more labor inten­sive jobs and save a higher per­cent of their earn­ings than aver­age Cana­di­ans. Stud­ies also show that immi­grants, on aver­age, become net con­trib­u­tors to Canada in less than 5 years; not ‘drains’ on the tax sys­tem. Like an invest­ment in a new busi­ness, it takes a few years to get estab­lished. The ‘Mosaic’ seems to appre­ci­ate dif­fer­ences instead of try­ing to elim­i­nate them. Immi­grants may find it more welcoming.

When immi­grants come to Canada, their strong fam­ily and com­mu­nity val­ues drive pop­u­la­tion rates higher rel­a­tive to the native-born pop­u­la­tion. This is pos­i­tive demo­graph­ics. In Canada, many of the immi­grants are either well-educated or very wealthy. They are buy­ing homes on arrival, espe­cially in Toronto and Van­cou­ver. Because these immi­grants have no prior credit his­tory with Cana­dian banks, many of them pay cash for their homes. This non-credit fueled buy­ing is not prone to a burst­ing bubble.

3. In addi­tion to immi­grants com­ing to Canada, there are for­eign­ers buy­ing homes in Canada for invest­ment, and for a “Plan B” escape. For exam­ple, Chi­nese in Shang­hai are buy­ing homes in Toronto and Van­cou­ver because there have been grow­ing restric­tions on buy­ing mul­ti­ple prop­er­ties in China, and also because they are set­ting up Canada as their back-up “Plan B” escape (in case things go bad in China).  They may sim­ply see Canada as being bet­ter place for rais­ing a fam­ily. Some of these for­eign­ers are not even immi­grat­ing Canada yet, sim­ply buy­ing homes for their poten­tial future in Canada.

4. As the finan­cial cri­sis sweeps the world, many immi­grants and wealthy fam­i­lies are com­ing to Canada. We have spo­ken to Amer­i­cans who fore­see the day they will want to escape from their country’s esca­lat­ing debt prob­lems and nasty par­ti­san grid­lock that makes solu­tions impos­si­ble. These are well edu­cated, upper mid­dle class Amer­i­cans that fear emerg­ing dra­con­ian laws tar­get­ing busi­nesses and the wealthy. Dur­ing the Amer­i­can Rev­o­lu­tion , Canada had a huge increase in immi­gra­tion; the Empire Loy­al­ists from the U.S. colonies. Are the Amer­i­can pur­chasers of Cana­dian prop­er­ties leav­ing the new Empire; an ironic twist of history?

5. In some respects, Cana­dian banks are more pow­er­ful than the Cana­dian gov­ern­ment. The Cana­dian gov­ern­ment started a key home insur­ance pro­gram in 1946 called CMHC. Today this insur­ance pro­tects the banks on a sig­nif­i­cant por­tion of their home mort­gage loans held. The insur­ance pro­tects the banks in case the home­owner walks away from the home mort­gage loan. The banks ben­e­fit greatly from this pro­gram – not only do the banks lower their risk, but they don’t even have to pay for the insur­ance. The insur­ance is paid for by the home buyer. So, it is in the inter­est of the gov­ern­ment to pro­tect home prices. The banks don’t have to con­vince the gov­ern­ment to do a ‘TARP’ type of bailout – it is built in. Fore­clo­sures lead the banks to go to the gov­ern­ment to claim their insur­ance pay­outs. There­fore, the Cana­dian gov­ern­ment will try every pol­icy within their power to sup­port sta­ble prices.

6. It is dif­fi­cult to empha­size how bull­ish today’s low inter­est rates could be when the ‘over­hang’ (excess inven­tory) is gone. The excess inven­tory in Canada was never as out­ra­geous as in the U.S. See some pre­vi­ous posts of ours, from over the years, that dis­cussed some of these issues. One post, in par­tic­u­lar: “The pri­mary dif­fer­ence between the two mar­kets is that Canada doesn’t have the moun­tain of fraud. Canada is not per­fect: just less bad.”

7. For the last 40 years, the world’s money has sim­ply been Credit. There is no ‘secu­rity’ other than credit to the government’s author­ity. Tril­lions of dol­lars have been cre­ated with the sov­er­eign debt of nations as the ‘bedrock’ – the safest of safe. Pen­sions, insur­ance com­pa­nies, and insti­tu­tional investors of the world have spent decades believ­ing that loans to gov­ern­ment are the safest invest­ments pos­si­ble. Tril­lions of dol­lars are just start­ing to real­ize that nations default on their debt; the secu­rity is not safe. The asset behind Trea­sury Bonds is the government’s abil­ity to col­lect more taxes from its cit­i­zens – not a safe bet in today’s econ­omy. Real estate pro­vides a tan­gi­ble asset; phys­i­cal security.

8. Low inter­est rates are bull­ish for real estate val­ues AND there are forces at work which could keep inter­est rates low for many years to come. Higher inter­est rates could cost the Cana­dian gov­ern­ment too much… they would fight it with any pol­icy pos­si­ble. A pre­cip­i­tous fall in home val­ues could cause mort­gage insur­ance pay­outs to the Cana­dian banks. Also, if Cana­dian inter­est rates go higher, the Cana­dian dol­lar gets stronger. Cana­dian man­u­fac­tur­ers and exporters would get hurt by a stronger cur­rency. They are a pow­er­ful inter­est group in Canada.

More­over, note the fact that the cen­tral bank of the U.S., the Fed­eral Reserve, has promised inter­est rates will stay at essen­tially 0% (on the short-term rates), and low in gen­eral for longer-term rates, into 2015 and maybe beyond that. Canada has a need to fol­low the U.S. lead on inter­est rates (due to the above-mentioned neg­a­tive effects on Canada’s exports).

Fur­ther­more, if either the U.S. or Canada were to raise inter­est rates, the cost of the national debt would con­sume more and more of the fed­eral bud­get (in the U.S., it  already con­sumes about 1/7^th of the entire bud­get at today’s arti­fi­cially zero inter­est rates)

And finally, a big objec­tive of the so-called quan­ti­ta­tive eas­ing (money print­ing) pro­grams is to keep inter­est rates low. What may not be under­stood by many peo­ple is that an esti­mated 80% of the hun­dreds of tril­lions in deriv­a­tives held glob­ally are in inter­est rates – there is no way that cen­tral banks can let inter­est rates go too high nor move higher too fast. The world could expe­ri­ence a deriv­a­tives melt­down that would make the 2008 finan­cial cri­sis look like a picnic.

There­fore, inter­est rates could remain low for many years to come, thereby help­ing to keep home prices up.

9. Canada’s Cen­tral Bank Gov­er­nor seems to under­stand Aus­trian Eco­nom­ics and the pos­si­bil­ity that Key­ne­sian Eco­nom­ics may have reached its end­point. This seems miles (kilo­me­ters) ahead of the cen­tral bankers in most countries

After con­sid­er­ing all of the above, will home prices ever go down?

In fact, prices are going down, not only in the U.S. but also in Canada. In real terms; real inflation-adjusted terms. Mean­ing, if you bought a home in Canada a few years ago, even though ‘nom­i­nal’ home prices have risen, in real inflation-adjusted terms, or in gold terms, or in commodity-based terms, home val­ues have gone down. This trend could con­tinue. Another way of say­ing this: If you buy a home today for $500,000, you could have bought 350,000 cups of Tim Horton’s cof­fee or 175,000 TTC (Toronto Tran­sit Com­mis­sion) tokens. It is pos­si­ble that in 10 years time, even though the home value may rise to $1,000,000, that much money might be able to buy only 100,000 cups of Tim Horton’s cof­fee or 50,000 TTC tokens. Real terms value is what really mat­ters. Who cares if you have mil­lions of a cur­rency, if you need bil­lions to live?

In other words, the ‘hous­ing bub­ble’ is deflat­ing some already (even if prices are still going up!) But very few are see­ing it! The depre­ci­a­tion of fiat paper cur­ren­cies, with no tan­gi­ble asset back­ing, hides deflat­ing bub­bles. Depre­ci­at­ing cur­ren­cies cre­ate opti­cal illusions.

If inter­ested, please con­tact us for ref­er­ences & fur­ther evi­dence to our claims. We are only say­ing that per­haps Cana­dian real estate prices won’t crash, as so many pun­dits are pre­dict­ing. We do believe there is some seri­ous imbal­ance (that may take years to fix) when a small, but nice condo in Florida (with great ameni­ties) can be bought for the price of a park­ing spot in down­town Toronto (no joke).

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Con­tact the Jef­frey Team for more infor­ma­tion – 416−388−1960

Lau­rin & Natalie Jef­frey are Toronto Real­tors with Cen­tury 21 Regal Realty.
They did not write these arti­cles, they just repro­duce them here for peo­ple
who are inter­ested in Toronto real estate. They do not work for any builders.
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