Canadian versus American Real Estate

The Toronto Real Estate Blog puts it this way:

The market across Canada is hot-hot-hot, according to the Toronto Real Estate Blog. It quotes one real estate expert as saying, a "fiasco" like the US housing market can't happen, "because there is no sub-prime lending market here."

The full story is here, along with a related story on the white-hot market in Toronto.

What could account for such dramatically divergent patterns?

Comments

[Harold Jarche]

Different tax laws, for one reason. Canadians cannot claim mortgage interest on their income tax. Also, Canada has only a few, mostly national, banks, so the market is not as competitive and the banks don't overextend their exposure (at least not on the consumer side of things). And to top it off - igloos are cheap ;-)

[Wendy]

There are a variety of likely contributing factors.

Right now the Canadian economy remains strong, unemployment in many areas is at an all-time low or a 30-year low. Wages are rising. Interest rates remain low by historic standards. With these things behind them, it makes sense for Canadians to buy homes or trade up.

There is no sub-prime mortgage crisis-fear (and in the US it may be the fear of the problem more than the problem itself that is causing housing demand declines) because Canada\s sub-prime lending sector is so small owing to a more heavily regulated lending industry.

There also has not been much speculative activity in the Canadian market generally -- with a few exceptions (certain Condo buildings in downtown Vancouver?). Once speculation creeps into any investment market (rather than fundamentals) the risk of a crash becomes much greater.

I think there is also a broader consumer and national economic confidence in Canada right now among Canadians -- and I don't think this same financial optimism exists in the US among Americans. Therefore Canadians continue to buy homes and upgrade their housing; Americans may be hunkering down fearing a recession.

(of course, if a recession does hit the US, Canadians may regret their mortgage-acquiring behavior as this will ripple into Canada)

Also, most Canadians live in big cities - Toronto, Montreal, Vancouver, Calgary. And these cities are performing well globally, and housing sales in these cities may be skewing the results somewhat, I'll have to look.

[John Pasalis]

I think there are a couple of important factors that differentiate our markets.

Canada's market is not being slowed down by the subprime collapse. Not because we don't have a subprime market, but as Wendy pointed out, because our subprime market is significantly smaller and more regulated than the one in the US. I recently wrote a post on my blog where I suggested that Canada's risk averse bankers and government regulators helped insulate our country from a similar subprime meltdown. If this is true, then maybe boring isn't such a bad thing.

The other important point to consider is that Canada's regulators recently made 40 year amortizations a reality for home buyers. Before that 25 years was the standard in Canada. This had 2 side effects. Firstly, it made buying a home a reality for many consumers who were previously priced out of the market with a 25 year am mortgage. Secondly, it allowed people to super size their home purchase. Home buyers who planned on buying a home with a 25 year am mortgage suddenly realized they could spend quite a bit more if they just increased their amortization. This increase in the amortization period is helping fuel the real estate market in Canada.

[Wendy]

John,

That's the first I've heard of the 40 year amortization option having an impact on housing. I haven't heard to brought up here in Vancouver (where everyone talks about real estate all the time ;-) Is it the talk of Toronto?

I didn't realize the regulation changed recently. I thought it had long been theoretically possible to go more than 25 years, but the banks and the mortgage insurance (for borrowing more than 75% of the home value) were all based on that 25 year figure making it challenging for those not familiar with the financial and lending system to pull off the longer amortization.

[John Pasalis]

Wendy,

You're right, it has been theoretically possible to get a longer amortization for some time now but once CMHC agreed to insure mortgages with up to a 40 year amortization, these products really hit the mainstream. Prior to that, the big banks couldn't offer long amortizations for insured mortgages and for some reason they wouldn't even suggest it for uninsured mortgages (more than 25% down).

RBC recently published a report that discusses some of these issues, you can find it here http://realosophy.typepad.com/qbr.pdf

Some of the highlights:
There is enough evidence to convince us that a very material amount of mortgage originations are going for much longer amortization periods. Unlike the cookie cutter conventional 25-year mortgage of the 1980s housing cycle, the past year has seen the introduction of 30-, 35- and 40-year extended amortization mortgages to broaden the ways in which households can cope with payment shock through higher rates.

...a rising rate environment may not crimp home affordability as hard as in the past, as typically measured by housing-related payments over income. To offset the impact on payments of our forecast for a one percentage-point hit to rates, a borrower would need to go from a 25-year mortgage to a 33-year amortization period, assuming the same house price, while still having the flexibility to pay off the mortgage faster later on. In the absence of higher rates, longer amortizations are contributing to upward price pressures in some markets, but also insulate against higher rates.

[Richard]

Like Wendy, first I've heard of this. Thanks for sending John. Can we get one. With the price of housing in Toronto, we could sure use one:-). We have a 25 year, 20 percent down fixed rate instrument. One thing is for sure: Canadian lenders are much more thorough in their vetting of borrowers, compared to say DC where we moved from.

[john trenouth]

Sure, Canada didn't get as drunk on real estate as the US seems to have. And continued strength in demand for Canada's natural resources means a relatively healthy and stable economy.

However, my guess is that the patterns are only divergent for now.

Debt markets are global, complex and tightly integrated. Don't just think about retail lending to home owners, but also consider how large financial institutions around the world hold each other's debt with no consideration for national borders. When lenders (big, global lenders) are forced to shed risk (for whatever reason) and start writing off billions in each others' bad debt, money gets real scarce for everyone. So the sub-prime problem in the US is a global sub-prime problem.

And while US real estate is only one of many factors in our current global credit crunch (way too many players chasing far too few dollars) , its a big one. And we're just at the beginning of it. So while Canada doesn't feel the pain yet, it will.

Also, the article's "expert" quoted as saying "it can't happen here" is an executive at one of the country's bigger real estate sales firm. In other words we have a real estate salesman telling us the market is great, so keep buying and selling folk! When a salesman tells you something can't happen here, it probably already happening.

John,
a 40 year mortgage has a trivial impact on affordability and thus market demand and buyer behaviour, so cannot explain any divergence between US and Canadian RE markets.

A 40 year term drops the monthly payment on a $500,000 home (entry level here in Van) by only $200 at 5% versus a 30 year mortgage. Seen from another perspective, moving from 30 to 40 years would allow a buyer who could afford only $450,000 to now afford $500,000 at the same monthly mortgage payment.

Ironically, about a third to a half of this $200 gets eaten every month by the increase in mortgage insurance premiums incurred at a 40 year versus a 30 year term. This leaves you with roughly an extra $100 per moth -- which translates into fractions of a percent in your debt-to-income ratio.

In other words, the longer term is meaningless for buyers, but a gold mine for lenders. At 30 years on $500,000 at 5% the bank will collect just under $400,000 in real interest payments. At 40 years this jumps to over $600,000. So the longer term nearly double lender profits, at no cost, while delivering no value to home buyers and providing no boost to the market at all.

And lastly, Harold,
Canadians cannot claim an income tax write-off on mortgage interest for their primary residence, but can claim the write-off for any property they own and rent out.

Also Canadians don't get hit with a capital gains tax for the sale of their primary residence (which I think does hit US home owners). And in some markets the capital gains tax savings might be more than the interest tax write-off. Of course getting the interest tax write-off pays every April and can allow you to reduce your tax deductions effectively allowing you to buy more home than a Canadian could at the same disposable income levels.

[Jennifer Jeffrey]

I immediately thought of you and this post when I read an article in the San Francisco Chronicle today about a young woman named Caroline Houck who is suing the real estate industry over her difficulty in getting a mortgage.

She's quoted as saying: "When you have unstable living environments, you have fundamental stress - that causes you not to be able to be effective in the world. All these future-thinking young people are spending all their time on housing and I don't think the older generation has any idea what we're experiencing."

An interesting perspective - though it might be wildly overstated (no one I know is spending "all their time" on housing, and if stress disallowed us to be effective, no one would ever get anything done).

Nevertheless, the correlation between creativity and affordable housing is something I think is worth careful consideration.

Here's the article: http://sfgate.com/cgi-bin/article.cgi?f=/g/a/2007/08/31/carollloyd.DTL

[John Pasalis]

John

I don’t think there’s any debate that increasing the amortization has a positive impact on affordability for home buyers while decreasing amortization has a negative impact on affordability. The former makes credit more available, the latter less available. The only question is whether or not this has had a significant impact on Canada’s housing market.

I work in the real estate industry and have been noticing this trend first hand for some time. The increase in the amortization limit was enough to get many first time home buyers I know on to the property ladder. Many were holding back because they couldn’t quite afford the home they needed, but the increase in the amortization suddenly made the homes they wanted affordable. Being able to spend an extra $50K on a home is significant for many first time home buyers. Perhaps this hasn’t been as obvious in Vancouver where home prices are significantly higher than in Toronto.

I was particularly excited to read the RBC report I linked to above which corroborated much of what I had been seeing first hand. If you have any analysis or reports that contradicts the RBC report, supporting your suggestion that the increase in amortization has not had a material impact on market demand and buyer behavior in Canada, I would be interested to take a look at it.

[West Toronto Realtor]

You cannot compare the situation on a real estate market in Canada with the U.S. real estate market. There is a subprime mortgage crisis on one site and a healthy economy, strong canadian dollar and buying power on the other site. So in my opinion the crisis in U.S. won´t have any impact on Canada, even if the Canadian economy was likely to follow American lead in history during U.S. recessions.

[Mark Argentino]

We may not have the same economics as the US and we may not drop as the US prices have dropped, but our market can certainly fall as it did in 1989 to 1994, see this graph that clearly illustrates this fact. http://www.mississauga4sale.com/TREBprice.htm#graph

All the best!
Mark
Mississauga Real Estate