Bubble Trouble

Earlier this week, I noticed an article from the Economist journal that stated Canadian homes were 35% over valued. Ironically, I also attended a local presentation this week where Scott McEwan of Altus Group was discussing the possibility we may be approaching a bubble in commercial and residential real estate markets.

What is a bubble? In real estate it is a rapid escalation in valuation until an unsustainable level is achieved. Bubbles are a naturally occurring phenomena. There was as housing bubble in the US in 2010. There was a dot com bubble in technology equities in 2000, and many others in our economic history dating back to 1630. While bubbles can be isolated in origin, they can become a contagion to other unrelated sectors; herein lies their danger.

The consequence of a bubble is a deflationary price correction, in housing prices/value drops. In real estate, owners of properties may be stuck with mortgages, which are greater than the current value of their property. One of the culprits of bubble expansion is cheap money, low interest rates, and capital liquidity or easy access to capital.

There is a growing chorus of concern regarding Canada’s housing market. The late Jim Flaherty, Minister of Finance, tried to cool the market as recently as 2012.  Stephen Poloz, Governor of the Bank of Canada, rating agencies and even the International Monetary Fund are raising alarms over the rise of housing prices relative to incomes.

Some local trends to watch in 2015, according to Altus Group, include decreased demand from institutional purchasers, as the asset values on PEI are generally below their investment thresholds.  Also, potential increased vacancies in downtown office space and apartments both of which have excess supply.

One way to measure the conditions for a bubble is to compare income inflation to property inflation. If the two are not in close parity there may be an issue. Scott McEwen points out “75% of Canadian tax filers earn under $50,000 according to CRA, in addition the debt to equity ratio of Canadians is 163.3 according to Stats Canada. At the same time housing prices are growing faster than wage growth. In Toronto benchmark prices rose 7.8% in February and 6.4% in Vancouver.”

Wages are not growing as fast as housing costs are escalating, and Canadians are being buried by increasing debt.

What does this all mean? We need to be mindful to not overextend ourselves when interest rates are low and money is available. Markets have a tendency to seek equilibrium. If the stock market is too high, it will ultimately find balance. There are winners and losers in any recalibration, the key is to try and land on the right side of a correction.