who want to buy, there is little chance that a booming flood of immigrants could push up house prices over the long-term.
The foreign investor argument is equally problematic in explaining an excess of demand over supply, which might force prices higher. The facts on the ground are difficult to determine. Statistics are as elusive as the mythical foreign buyers who seem to be a major (unpaid) ally for every sales campaign for luxury condos in Toronto.
We can’t track foreign investors as easily as immigrants since there is no record that identifies a house or condo buyer by occupation or country of residence or even type of buyer such as family, individual, or corporate. Most foreign investors in the Toronto and Vancouver areas, which are the areas with the most significant amount of foreign investment purchases, concentrate on the condominium market probably because there is little need for on-site supervision. Based on anecdotal evidence only, many condos in Vancouver and Toronto sit empty as investors choose to leave them unoccupied, at least in the short-term, because perhaps the plan is to flip the unit for a quick profit. This type of investment is really speculation, not investment if it is left empty because there is no income associated with owning the condo, only expense. Of course if it is rented it could be an investment, but a poor one since expenses normally exceed income in Canada’s condo market. The strategy that would yield a profit for the speculator is a sale that depends on finding a buyer willing to pay a higher price than the speculator. Of course, taxes and condo fees continue to eat away at the potential profit the longer the unit is held prior to flipping. It’s hard to imagine that foreign investor demand will be anything more than a temporary lift to the condo markets. It could go on for a few years but eventually foreign investors will move on to the next hot property market or they will sour on the Canadian economy or they will notice that their favourite speculation, the condo, is no longer rising in price and therefore not likely to yield any quick profits.
But there is a more substantial, domestic and permanent source of demand for housing that might be a factor in the bubble, and that is young people who reach the age when they want to get married and move out of their parents’ home to live independently. This is known in the economic world as family formation.
Family Formation and the Bubble
Economists that examined the bubble and collapse in the United States noted that a substantial drop in household formation after the financial crisis of 2009 hurt the demand for housing and contributed to the housing crash there. Analysts estimate that as much as one-third of the U.S. male population between the ages of eighteen and thirty-five lives at home with parents, highlighting the dramatic drop in family formation. Perhaps that’s why sales of the computer-based game Grand Theft Auto have never been better.
So what has happened with young people born in Canada who have reached adulthood over the last decade? As you would expect, their experience is very similar to that of their contemporaries in the United States. In Canada, these young people, known as Generation Y (or millennials), are very slow to leave home and establish independent living quarters, especially compared to previous generations.
Forty-eight percent of the so-called late baby boomers (those born between 1957 and 1966) were married during their twenties, compared to only 33 percent of millennials born between 1981 and 1990 (who were twenty-five to thirty-four years old in 2015). This represents a huge drop in the rate of family formation, with more than 67 percent of millennials remaining single. Although single people might be homeowners and couples might live together but not get married, they are much less likely to buy a home than are their married cohorts.
An even more important trend regarding these young people as potential home buyers is this: a remarkable 51 percent of those aged 20 to 29 live at home with their parents (based on 2010 data), compared to just 28 percent of the late boomers at a similar stage in their lives.
Obviously two well-paying jobs are a prerequisite to buying a house and moving out of the parents’ basement. But as was shown at the beginning of the chapter, Canadian income growth and employment surpassed that of the United States by a wide margin, primarily because of commodity demand and prices. So it’s a puzzle why so few young Canadians have taken the leap to move out on their own. Perhaps the high cost of housing is making it impossible for these young people to get started on the homeownership ladder, even when their parents might like to give them a push.
In fact, under closer examination, we see that while median income growth has been good, it has been relatively poor for the millennials who would normally be forming families and buying entry-level housing. While gains for the top 1.0 percent have been spectacular, for the rest of the population (the 99 percent who make less than $200,000 per annum), income increases have been very modest in Canada even with resource wealth, and especially after adjusting for inflation. This trend goes back several decades. For millennials, that job as a Starbucks barista isn’t providing enough income to rent an apartment much less buy a home or condo.
According a study by the U.S.-based Pew Research Center, millennials are the first generation in the modern era to have “higher levels of student loan debt, poverty and unemployment, and lower levels of wealth and personal income than their two immediate predecessor generations ... at the same stage of their life cycles.”[14]
We can conclude that factors such as household formation, immigration, foreign investors, and income growth, even when taken together, cannot explain the amazing surge in house prices. This lack of support for house prices makes the appearance of this bubble even more unusual — and much more precarious. We now turn our attention to the one major contributor that did drive the bubble’s formation and housing price increases; one that will play the leading role in the ensuing crash in Canadian real estate.
Chapter 2
The Elephant in the Room
It thus seems likely that the rise in private sector debt was the fundamental cause of both the great depression of the 1930s and the recent great recession.
— Andrew Smithers, The Road to Recovery[1]
How does one explain the boom in Canadian home ownership and housing construction and the nation’s top world ranking in housing prices? In a word: debt. Lots of it, in fact, provided under generous terms allowing total private debt to grow at an unprecedented and unsustainable rate. Private debt is made up of household debt and nonfinancial business debt, split about evenly between the two types.
The total amount of household debt grew at a breathtaking pace, made possible by eager cooperation from banks that provided credit on easy terms at lower and lower interest rates. In the short-term, speculation using cheap credit can overwhelm income and household formation as drivers of demand for housing — and that is what’s happened in Canada; the exponential growth in credit has overwhelmed the normal housing cycle. We can see from Figure 2.1 [2] that total private sector debt went from about 100 percent of GDP to 200 percent of GDP, a doubling of debt enabled by a bubble in house prices and government-sponsored insurance for lenders.
Homes are bought with credit or borrowed money, in the form of mortgage loans from banks or other lenders. If house builders had to wait for first-time house buyers to save the entire purchase price before buying, they would all be out of business and the housing market would be mostly for renters. As collateral for the loan, the lender takes a mortgage that contains a repayment schedule and lodges a caveat against the title of the property. The lender — in Canada it’s often a bank — collects a monthly payment for the term of the mortgage. As the owner-occupant makes payments the principal gradually declines and the equity or level of ownership grows and the mortgage value shrinks. With rising house prices growth in the owner’s equity is the rule. But occasionally a borrower gets into trouble after losing a job and fails to pay
