Are we worrying ourselves into a housing crash?

Garry Marr, The Financial Post

 

Maybe this is telling us you shouldn’t buy the biggest house

Just sit back and do nothing. It doesn’t sound like the most proactive advice when it comes to the housing market, but it might just be what everybody needs to hear.

Panic is the worst thing that could happen because when that mentality sets in and people become irrational, it’s hard to forecast how low prices will go, says Benjamin Tal, deputy chief economist at Canadian Imperial Bank of Commerce. He is among the many who predict that prices will fall but by a moderate level that does not resemble the U.S. crash.

Considering where the house fits into our personal balance sheet, Canadians have good reason to fear a decline in prices and the impact on their wealth

“There is nothing to fear but fear itself,” says Mr. Tal, paraphrasing the famous quote from U.S. president Franklin D. Roosevelt before his election. The economist’s worry, and that of others, is that we are now talking ourselves into a housing crash by creating a scenario in which every new statistic is interpreted in the most negative way with an eye on trying to constantly compare the Canadian housing market with what our neighbours to the south experienced just before their housing prices plummeted by as much as 50% in some markets.

A study this summer by Environics Analytics WealthScapes found the average net worth of a Canadian was $363,519, with $269,024 of that figure the net equity in real estate.

When you see headlines screaming that Canadian household debt has reached a record level, an eerily similar spot to where Americans were before the market crashed there, it adds to concern. But the similarity ends with the headline-grabbing number, Mr. Tal says.

The distraction of [hearing about these debt levels] is more of a concern than the debt

In the second quarter of this year, the debt-to-income ratio rose to 163.4% from 161.8% in the previous quarter. The previous quarter had been revised from 152% using a new measurement.

“The quality of the debt is much different here,” says Mr. Tal, who is the process of writing a report that will put that thesis to the test. He maintains the people who have taken on more debt have a much higher credit score than the Americans who did the same prior to their market crash.

Collapse is too strong a word when it comes to housing prices. You can’t talk yourself into that but you can talk yourself into a slowdown or a delay

Another key factor that is ignored in the discussion is how much of that debt is locked in for longer terms and not subject to the vagaries of rising rates. Mr. Tal says 70% to 80% of Americans were in variable products at the peak while the Canadian figure is 29%, according to the latest survey from the Canadian Association of Mortgage Professionals.

Still, he worries the wrong message is getting out. “The distraction of [hearing about these debt levels] is more of a concern than the debt,” he says.

But could people actually talk themselves into a housing correction? Moshe Milevsky, a finance professor at the Schulich School of Business at York University, doesn’t rule out that scenario.

“Collapse is too strong a word when it comes to housing prices. You can’t talk yourself into that but you can talk yourself into a slowdown or a delay. It is one of the things behavioural economists are starting to appreciate that classical folks didn’t,” Prof. Milevsky says. “Attitudes matter. It used to be that just facts matter, but sentiment is going to be just as important. If people start to believe real estate prices are slowing down, they’ll slow down their purchases.”

It doesn’t help with confidence when the federal minister of finance says he has his own worries about the housing market and then imposes a set of new rules to make it more difficult to borrow.

“I remain concerned about parts of the Canadian residential real estate market, particularly in Toronto but not only in Toronto. So that is why we are intervening once again,” Finance Minister Jim Flaherty said before imposing his latest changes on consumers, which included a lowering of amortization lengths to 25 years from 30 years.

Prof. Milevsky says the government calling the market overheated could be having as big an effect as the rule changes themselves.

It’s almost as if you have to sit back and watch this unfold

“The rule changes only affect people actually going out and getting a house but Flaherty saying prices [might be] inflated affects anybody who hears it,” he says.

So what can you really do about to deal with your worries? Not much.

“It’s almost as if you have to sit back and watch this unfold and say, ‘Gee, I wish I could capitalize on it,’ ” says Prof. Milevsky, adding you could potentially short some real estate stocks and indexes. “But they are so broadly based and illiquid. The bid and ask on them is wide.”

The issue might be a little more simple for people who don’t have a house and are waiting and contemplating whether it’s time to buy one, or considering whether to buy a big or small house.

“The conventional wisdom was to buy the biggest house you can afford because you are going to make a lot of money. But maybe this is telling us you shouldn’t buy the biggest house,” Prof. Milvesky says.

Everybody believes something might be happening but so far it has not affected their conduct

But Gerald Soloway, chief executive of Home Capital Group Inc., says the rules really haven’t changed much for buying a house: Don’t time the market and buy what you can afford, he says.

But he acknowledges there seems to be an insatiable appetite for all information about the sector. Mr. Soloway says he’s become the most popular guy at cocktail parties.

“Constantly, I’m always asked,” he says about people wanting to know his opinion about where the market will go next. “This has been going on the last four or five years, everybody believes something might be happening but so far it has not affected their conduct.”

His own data show the fears appear overblown and he agrees with CIBC’s Mr. Tal that the credit quality of Canadians is better than Americans. “You look at our portfolio, half is insured [and backed by the government] and half is uninsured and people are paying their bills. Year over year, our arrears are down slightly and not dramatically,” Mr. Soloway says. “They were not very big to begin with.”

Mr. Soloway just doesn’t believe negative talk is enough to derail the housing market, just as negative sentiment is enough to drive us into recession.

“It can move the market but it’s not enough to change the fundamentals,” he says.

Like others, he thinks we might see a 5% to 10% easing in prices across the market but he believes builders can still make strong profits at that level. It’s also no reason to sell, especially when you factor in transaction costs that can be as much as 10% in some cities.

Besides, are you really going to pack up your home, move your kids and start renting as you try to ride out a potential downturn in the market?

Phil Soper, chief executive of Royal LePage Real Estate Services, says there is little benefit to timing the market.

“Potentially in some markets you could save a few bucks moving into a rental situation but it’s not as easy as you think,” he says. “If you live in a single-family home, the inventory of properties can be limited if you want your kids to stay in the same school or area. If you live in a condo in a large city, sure you can move into renting that same condo.”

Mr. Soper sticks by the notion that, over the long run, house prices rise and he thinks the consumer will stick it out and ignore the negative news. “People pay more attention to the reality of low interest rates than the hyperbole that finds its way into the discourse about housing,” he says. “There has been so much see-sawing in the economy that people are immune to whipsaw reactions now.”


gmarr@nationalpost.com