Real Estate Anxiety Sweeping the Country

This was not the Saskatoon Alex Trauzzi remembered.

Real Estate Anxiety Sweeping the Country

This was not the Saskatoon Alex Trauzzi remembered.

A few years ago, Trauzzi, 24, had been drawn to the Prairie town for work and grew to love it. He met his fiancée there. And he vowed that after finishing college in his hometown of Winnipeg, the couple would return and buy their first home there. "We saw it as a great place for fresh starts," he says.

But when the couple moved back to Saskatoon earlier this year, Trauzzi scarcely recognized the place. The housing market was ablaze with bidding wars, double-digit monthly price gains and frenzied speculation. Modest bungalows that had sold for $187,000 in the fall of 2006 were by spring changing hands again for $280,000, without so much as a fresh coat of paint. It was insane. Trauzzi, a service technician, felt there was no way he could afford those kinds of prices for a starter home. So after just nine months, he fled back to Winnipeg where he bought a home earlier this month for slightly more than $120,000. Not a moment too soon. Even the Peg is quickly becoming unrecognizable thanks to REAL ESTATE fervour. "I could easily turn around and sell my house for five or 10 grand more than I paid for it," he says, with a note of astonishment in his voice. "I don't know if there's a bubble that's going to burst or not, but if there is something that's going to happen, it's going to happen right across the country."

Trauzzi isn't alone in feeling anxious about the housing market. Across the country, the B-word is on the lips of Canadians. First-time buyers are wondering whether they'll ever be able to afford their own place. Some wonder if they should buy now, or wait in hopes that prices will fall. Those who've already bought worry that they've paid too much - and will wind up overextended if interest rates jump - or that they'll never be able to move up to something bigger. Even house-rich Canadians whose equity has soared in the frenzy fret that they can't take advantage of their position - where could they afford to buy if they sold now? And what if you're counting on your house to finance your retirement, and its value plummets? At the same time many fear the carnage in the U.S. housing market will make a collapse here inevitable. So with one eye on soaring prices here, and the other on the troubles south of the border, you can't really blame Canadians for feeling like they're living on the edge of a cliff.

Yet step back from the real estate listings for a moment and things start to take on a different hue. Yes, prices in Canada have risen dramatically in the last few years, but those gains are nothing compared to what's been experienced in other countries, or even here, in years gone by. What's more, thanks to continued low interest rates and new types of longer-term mortgages, housing affordability in some big cities remains decent compared to what we've seen in past booms. In fact, the evidence suggests that in Canada, if anything, we're not at the top of the market and there's still room for house prices to move higher in certain parts of the country.

There's no question the housing market has been on a wild ride. The average Canadian family has seen the value of their home jump more than 10 per cent a year for three years in a row. Prices overall are up 60 per cent in the last five years. But national averages never tell the full story. While prices in cities like Ottawa and Montreal have grown slowly, house prices in Toronto are up about 86 per cent over the last decade to an average of $394,000, while the average home in Vancouver, at $570,000, has jumped 73 per cent since 2003 alone. In Oilberta, the average Calgary home has doubled in just four years to $432,000.

To buy at those prices, Canadians have had to pile on mounds of new debt. Between 2000 and 2006 the total amount of outstanding residential mortgages ballooned by 62 per cent to $694 billion, according to the Canada Mortgage and Housing Corporation, and many expect that figure will top $800 billion this year. It used to be said you couldn't talk to a Vancouverite for more than five minutes before the topic of real estate came up. Now that applies to just about everybody.

But as Canada booms, America's housing pain hangs over the party like a dark cloud. Across the U.S., house prices declined between the second and third quarters for the first time in 13 years. In specific markets in Michigan, Ohio, Florida and California, home prices fell as much as five per cent. There are some who predict - or is it pray? - the drop is just a brief pause before bidding wars erupt once again. But they are increasingly in the minority. Moody's, the debt rating agency, predicts U.S. prices will fall by 15 per cent over the next two years as the market softens. Once-hot urban centres in California and Florida could even tank by more than 30 per cent. "In the United States, they basically went from double-digit price growth to an outright price correction in about six months," says Craig Alexander, deputy chief economist at TD Bank. "That's a classic bubble bursting."

What's driven things in the U.S. was a parlous mix of overheated financial markets, a culture of debt accumulation, and a heaping dose of pure speculation. The problems began a few years ago when Americans with poor credit and no cash for down payments were lured into the housing market by lenders offering subprime mortgages. Lenders had many tactics, but the most popular involved offering adjustable-rate mortgages with absurdly low initial payments. Many buyers jumped in, only to run into trouble once rates were cranked up. Borrowers eventually began to default on their mortgages. As many as two million Americans may lose their homes and pull the rug from beneath the housing market. As Mark Zandi, an economist at Moody's, said recently: "This is the most severe housing recession since the post-World War II period."

No one would dare claim the U.S. meltdown doesn't pose at least some threat to the Canadian economy and, hence, house prices here. Our two economies are closely linked. If America falls into a deep recession, it could bring global economic growth to a standstill. But that's by no means inevitable. Emerging markets are still strong, and that's driven commodity prices. With its bounty of minerals and resources, Canada has seen record low unemployment. Even in Ontario, where manufacturing has been hard hit by the high loonie, the province has added jobs over the last year. The situation bodes well for continued strength in the housing market, assuming employment remains strong.

But the biggest difference behind the situation in Canada and the U.S. has to do with fundamental differences in the two markets. At the peak of the U.S. housing market, sketchy subprime loans accounted for more than 30 per cent of all American mortgages from 2004 to 2006. In Canada, they never made up more than five per cent of the mortgage business. That's largely due to the buttoned-down style of Canadian financial firms and borrowers. But it's also because Canada's big banks control so much of the lending market. Absent the aggressive competition America's financial services sector is famous for, there just never was the urge up here to pursue the riskiest slices of the market.

Instead, the main driver of our boom has been this country's firmer economic fundamentals, say analysts. There are speculators in the market - there always are. But a tight labour market has led to rising incomes, allowing people who never thought of owning a home to claim a plot of land for their very own. "I can understand the concerns people have about the Canadian housing market," says Alexander. "But I think what's driven things here is fundamentally different so the risks are far less." Adds real estate analyst Frank Clayton: "There is no bubble."

Those who lived through the last one know all too well what it's like to watch helplessly as your home sinks in value. Hans van Monsjou, who has owned his house in Mississauga, Ont., for 22 years, saw prices soar in the bubble of the late 1980s. Then the market turned. Over the next few years, his home shed about one-quarter of its value. Fortunately for van Monsjou, who works for a financial firm, he bought at a good price and never slipped into the red. But like many Torontonians, he saw foreclosure signs spring up all around him.

One real estate cycle later, and van Monsjou's home has bounced back. At $750,000, its worth nearly 70 per cent more than at the last peak. And once again he's feeling a bit jittery. Van Monsjou doesn't expect a major collapse, because mortgage rates are well below the double-digit figures that marked the last boom. But he does think Canadians are putting too much faith in the economy remaining strong. "There may be a false sense of security," he says. "We may be living off the last fumes here."

When the last bubbles burst in the 1980s, it brought many Canadians to their knees financially. In 1989, house prices in Toronto dropped 41 per cent and took more than a decade to recover. Vancouver fared even worse in the early 1980s. In just three years, house prices in the city were chopped in half. With interest rates running into the double digits, owners simply couldn't handle rising mortgage payments when their homes had lost so much value.

But this boom is decidedly different than the last one. Folks in Toronto, for instance, may feel like prices are getting out of hand, but compared to the late 1980s, this round of gains is more modest. Back then, house prices shot up 175 per cent in the five years leading up to the market peak, according to figures from the Toronto Real Estate Board. This time around, Toronto homes have climbed just 40 per cent over the past half-decade.

A better way to gauge the tenor of housing markets from one era to the next is to look at housing affordability. In simple terms, it measures the share of an average family's household income that is required to service the mortgage on an average priced home, and captures changes in earnings strength and interest rates. By that measure, several markets remain relatively affordable compared to more manic days gone by. In Toronto, mortgages eat up 27 per cent of household income, according to research firm Altus Clayton, down from a peak of 40.4 per cent in 1990. In Calgary, families pay more to maintain their mortgages than in 1989, at 27.9 per cent, but have yet to reach the heights of the 1981 boom, when it took 31.1 per cent. Even when you factor property taxes and utilities into the equation, as RBC Economics does with its affordability analysis, the Canadian market overall is still more affordable than at past peaks. In some cities, like Saskatoon and Calgary, houses are less affordable than in 1989, though those heights were never as pronounced as in Toronto, which still looks affordable.

Financial planners suggest a mortgage should never take up more than 32 per cent of a household's gross income, so clearly many Canadians are pushing their limits. But the saving grace has been low interest rates. Five-year fixed mortgages can still be had for around 5.99 per cent. Economists believe rates in Canada will remain quite low through 2008 and into 2009 due to continued uncertainty in the global economy.

But low rates only partly explain why experts don't believe the market is about to collapse. Canadians have warmed to a new breed of mortgage. In the past, the longest a homebuyer could take to pay off a mortgage was 25 years. In the last year, lenders have begun offering loans that can be stretched over four decades, which lowers monthly payments. For instance, a $300,000 mortgage amortized over 25 years at six per cent would result in monthly payments of $1,919. The same mortgage, over 40 years, will leave an extra $284 in your pocket each month. This comes at a steep price: borrowers fork over a lot more in interest payments in the long run.That same $300,000 mortgage over 25 years would ring up $275,825 in interest charges. Over 40 years, the interest charges would amount to $480,000.

Economists say 40-year mortgages have breathed new life into Canada's housing market, which had begun to show signs of slowing. Suddenly thousands of people who had been squeezed out of the market are able to afford their own home. That's good on many levels - home ownership brings a sense of pride and acts as forced savings. Critics, meanwhile, argue these new mortgage products pour gasoline on an already raging fire.

Adding to the notion that there's still life in the market is the fact that Canada has lagged in the global housing race. According to The Economist magazine's house-price indicator, which tracks two dozen countries, Canada has seen relatively modest gains. Between 1997 and 2007, house prices here rose 78 per cent. That may seem steep, until you consider the stratospheric gains in other countries, such as the U.S. (165 per cent), Spain (190 per cent), Britain (213 per cent), and Ireland (240 per cent).

The fact is house prices, even in some of Canada's hottest markets, almost look like a bargain. Each year Demographia, a real estate research firm, ranks more than 150 cities in North America, Europe, Australia and New Zealand on their affordability. Toronto and Calgary, for instance, are tied for 71st, well below New York and London, but also well back of Melbourne, Dublin and Boston, too. In fact, Vancouver and Victoria are the only Canadian cities to rank among the top 25 least affordable, at 13th and 23rd respectively. "The evidence would suggest a city like Calgary is still much cheaper than most Western cities, even though it's growing exceptionally fast," says David Seymour, a policy analyst for the Frontier Centre for Public Policy. He can speak from personal experience. Seymour recently moved to Saskatoon from New Zealand. He says a $180,000 home in the Prairie city would easily fetch in excess of $1 million in Auckland. Sure, the weather and scenery aren't what Kiwis are used to, but that doesn't fully explain the discrepancy in prices. "Canadians really don't know how lucky they are in terms of housing affordability, with the exception of Vancouver," he says.

On the contrary, Canadians are convinced prices here are out of control. An Angus Reid poll conducted earlier this year found two-thirds of people fret that houses in their neighbourhoods are overvalued and becoming more so. Why are Canadians so sure house prices have reached untenable heights, when by several measures many markets in the country remain affordable? A big part of it has to do with optics. A host of shiny new condominiums have been unveiled recently, and the sight of buyers lined up for days to snap up units is enough to unnerve anyone. That was the case last month in Toronto, when units in the high-profile 1 Bloor project went on sale, and fights broke out among real estate agents lined up for a piece of the action. When grown men and women start acting like kids in a candy shop, the housing market must be out of whack.

Some are convinced the end is nigh. The housing bubble's imminent demise is a regular topic on Garth Turner's blog. The Liberal MP and author argues baby boomers fuelled a housing bubble of "Biblical proportions" that is about to crash down. Of course, Turner has predicted prices were set to fall for several years now, and instead they've done the exact opposite. The thing about making predictions in a market as cyclical as housing is that eventually you'll be proven right.

But there's no denying hot markets in the West are cooling. Take Edmonton, for instance. After 15 years of meagre gains, housing prices exploded over the last two years. For the first half of this year alone, prices jumped 40 per cent. Just as quickly they've pulled back. Last month, the average residential property price fell 6.5 per cent from October to $325,060, according to realtors. Perhaps sensing trouble afoot, one developer last month turned to gimmicks - buy a semi-detached show home and get a Volkswagen Golf at no extra cost.

Are these signs of a bubble bursting? Falling house prices are always a cause for concern. And if the market decided the good days were over, and rushed to sell, a collapse could be self-fulfilling.

Many Canadians are trying to decide whether to keep playing along or wait for things to cool off. Eric Giesbrecht, a personal chef in Calgary, was one of them. He and his wife, both in their 30s, would like to have children, but their townhouse-style home isn't suitable. Yet even though their existing home has surged in value, finding a place with a yard would mean a lateral move into a small house far from downtown. Three months ago, Giesbrecht gave up and stopped searching. "If we were a bit more risky, or just greedy, we could take the equity we have here and jump into some place that costs $600,000," he says. "But everybody seems to be tightening up the strings and cutting off spending. If prices drop you're already maxed out before you go in. It's a stranglehold."

But just because everyone's worried doesn't mean there's a bubble about to burst. TD's Alexander points to the slow market in central Canada between mid-2004 and 2006, which followed a period of frantic price increase. He thinks Western Canada will follow the same path, with more modest single-digit growth next year. "Bubble's burst, they don't decelerate over several years," he says. "When you see prices cool over a period of several years, it gives you some confidence that you never had a bubble to begin with."

At least that's what they're hoping back in Saskatoon. Last December, Meghan Rauckman, a single mom, signed up to buy into a planned townhouse development, only to learn in April the developer had pulled out. A lawsuit is underway, but in the meantime house prices soared. Rauckman eventually bought a smaller home, but at $80,000 more than what she'd originally planned. Watching prices skyrocket, and hearing all this talk of bubbles in the market, has only added to the strain. "If my place dropped in price, and I couldn't afford to make payments and had to sell, I know I'm going to lose money," she says. "That's really added to the stress."

No one ever said buying a house was easy - or worry-free. But as the real estate boom rages on, homeowners have little choice but to cross their fingers and hope for the best. Not all booms become bubbles, but when they do, watch out for the pop.

Maclean's December 31, 2007