I wanted to make this article to help answer the question: How bad is it really? And to be clear, it's impossible to predict where things will go from here and to try and time a crash. And I'll try to explain the important variables that will influence the outcome one way or another without making a grand statement about how now is the time to short Canadian housing. But many Canadian households are currently experiencing significant financial strain. And while there are some unique advantages Canada has when compared to the US in the real estate space, there are also some pretty depressing unique features to Canadian real estate that make the area harder to manage than an asbestos-laden popcorn ceiling. So let's talk about real estate in Canada. Buckle up, it's going to be a ride on today's plain bagel.
Resilience in the Face of Crisis: A Comparison with the US Market
During the 2008 financial crisis, the US housing market was pummeled. Rising interest rates combined with unsustainable lending practices caused mortgage delinquencies to surge and home prices to lose a fifth of their value, contributing to one of the worst economic ruts in U.S. history. Just north of the border, however, things were a lot less dramatic. Despite Canada's heavy economic ties to the US, home prices in the country fell just 9.2 percent from their peak in 2008 to their trough in 2009. And while it took nearly a decade for U.S. properties to return to their previous high, Canadian properties recovered all of their lost ground within two years. Many attributed this resilience to Canada's sound mortgage lending practices and robust banking industry, whereas America's fragmented and loosely regulated finance sector had allowed the proliferation of risky loans, speculation, and leverage upon leverage in the real estate space. Canada's mortgage lending activity was much more conservative, with the market being dominated by large, well-capitalized, and diversified players who were carefully watched in their investment banking and mortgage lending activities by regulators.
The Double-Edged Sword of Housing Resilience
The tenacity of Canadian housing has, however, proven to be a double-edged sword because while America's real estate slump did have the silver lining of making properties more affordable for a period of time, Canadian properties never experienced a similar correction. Even after accounting for the recent slump from their pandemic high in 2022, Canadian home prices have doubled in the last decade compared to hourly wages, which have increased a meager 24 percent roughly over that same time period. Now, it's estimated that homeowners require a minimum income of one hundred and eighty thousand dollars to afford the average property price of 750,000. The median family income sits at roughly 121 thousand dollars, or thirty-three percent below this amount. But that's at the aggregate level. Things are craziest when you dive into Toronto, Ontario, and Vancouver, British Columbia, two of the top three most populous cities in Canada with roughly a quarter of the population between them.
Average prices in these two cities have reached 1.1 and 1.2 million dollars Toronto and Vancouver respectively. That's roughly nine times the average economic family's total income for both cities or double that in some markets. If you were hoping for a detached home, making the traditional concept of homeownership for young Canadians a bit of a pipe dream in some areas. Now, for anyone outside Canada, this might all sound a little shocking to you because if you look at a map of our beautiful country, you'll notice that the one thing we aren't missing is literal space. Canada is the second largest country in the world and ranks just 38th in terms of population size.
How could a country with so much of this key ingredient struggle to house its population? Well, while there are many rural townships across the country where you'll find more affordable housing, Canada's population is heavily concentrated around its cities, with roughly three-quarters of the population living in large urban centers. And the density in these areas is only going up. Between 2016 and 2021, Canada had double the population growth of every other G7 country at 5.2 percent, thanks primarily to immigration, the vast majority of which was to the country's larger cities. In fact, Canada saw its population surge 2.7 percent last year alone, welcoming over 1 million people for the first time in its history.
The Supply-Demand Imbalance: A Key Factor in Canada's Housing Woes
But while population growth obviously plays an important role when it comes to real estate, immigration has played an important role in supporting the economy and Canada's aging population. Not to mention, there are many cities in the U.S. with a higher population density than Toronto that don't struggle with sky-high property prices. So what's causing Canada's market to stand out in terms of affordability? Well, simply put, one of the key differentiators here is a lack of supply. Canada has the lowest housing supply per capita out of the G7 nations at 424 units per 1000 people, with the federal housing agency estimating that Canada would need 5.8 million new homes to restore affordability by 2030.
That's 2.5 times what the country is on track to complete. And while building more homes seems like a simple solution here, there are some meaningful roadblocks to that objective. For one, there's a lack of skilled labor in the space, with Canada experiencing a record high of 80,000 vacancies in construction. Part of the reason immigration is actually viewed by many as being part of the solution, not the problem. Bureaucracy and red tape have also made building real estate in Canada a particularly cumbersome affair. One expert estimates it takes 8 to 10 years to go from acquiring an undeveloped piece of land to building the property in Toronto. And zoning restrictions imposed by municipalities across the country have made the densification of land incredibly difficult. In Toronto, for example, the majority of land only allows for single-family developments, with mid to high-rise buildings only typically being permitted in limited locations, despite it being the most populated city in the country. Canada's government has tried a few things to solve housing affordability, such as a recently announced tax-sheltered savings account for first-time home buyers, a ban on foreign buyers, and a vacancy tax introduced at the federal, provincial, and municipal level in some cases. More attention has also been brought to the zoning restrictions of major Canadian cities.
But we've yet to see meaningful progress on the supply side of things. In fact, Ontario's Premier Doug Ford recently found himself in hot water for planning to open the protected Greenbelt around Toronto for development, only to reverse those plans on allegations of corruption. So, yeah, building more homes has been easier said than done. And this imbalance of supply of homes with actual demand for property has only been exacerbated by the rock-bottom interest rates of the last 15 years or so and the resulting inflow of investment capital into the space. Following the 2008 financial crisis, many central banks for developed countries, including Canada, dropped their policy rates to near zero to try and bolster lending activity. This caused mortgages, the loans for buying properties, to become dirt cheap, while making fixed income investments, which now paid investors a lower yield, a lot less attractive. As a result, many investors took their money and put it into real estate, given that it could be bought with cheap debt, rented out for extra income, and had a track record for actually appreciating over time.
The Debt Dilemma: How Canadian Households are Struggling
Now, this factor is obviously not unique to Canada. We've seen similar asset price inflation in the US thanks to its low interest rates. But given how long it's been since Canada has experienced a real estate correction, prices were already starting off with a relatively high base. And with Canada's particularly resilient reputation, investors flooded in. In 2020, it was estimated that one-fifth of all homes in British Columbia, Ontario, New Brunswick, and Nova Scotia were investor-owned, with this percentage being as high as 42 percent in some subdivisions of Vancouver with higher student populations. It is worth highlighting that this investor demand has primarily been domestic so far, with non-resident ownership as high as 14.9 percent in the student-centric subdivisions of Vancouver.
Across the province of British Columbia, the rate is much lower at seven percent of condominium apartments and 2.5 percent of houses. And while units not occupied by their usual residence is at roughly seven percent for both Toronto and Vancouver, some of which may be vacant, this figure can also include certain types of student housing or other forms of housing, which by definition are not occupied by usual residents. But they're being mixed figures and debate on how many properties in Canada are truly left vacant by investors and the like. So while foreign investors have had an influence on pocket regions of Canada, instead it's truly the combination of all these variables, the policies encouraging high demand and speculation without a subsequent follow-up in supply.
And as Canadians have tried to keep pace, something else has crept up to pretty concerning levels. As prices have outpaced savings, buyers have borrowed the difference, contributing to record levels of debt in the country. Canadian households had a record dollar 85 of debt for every dollar of disposable income in the third quarter of 2022, with 75 percent of this debt being tied to mortgages. This is the highest level of household debt among the G7 nations and makes Canadians some of the most indebted people in the world, with household debt to GDP being higher now in Canada than it was in the US leading up to the financial crisis.
The Interest Rate Conundrum: A Tipping Point for Many Canadian Households
Now, with the Bank of Canada recently hiking its central bank policy rate from 0.25 to 5 to combat inflation, we have seen a cooling down in the space recently, with home prices and debt levels in the country both pulling back. But in the near term, these same rate hikes have actually exacerbated the affordability problem. After all, the rate you pay on a mortgage is a determining factor in the size of your monthly payment. With the Bank of Canada hiking its policy rates so drastically, we've seen mortgage payments skyrocket across the country. Mortgage payments as a percentage of income have reached 59.3 percent in the second quarter of 2023, up from 43 percent just two years ago.
This not only discourages new demand for real estate, perhaps an intended outcome, but it also hurts those already in the market. If you took out a 500,000 25-year mortgage at the typical one percent variable rate available to you on January 2022, your mortgage payment at the now 6 percent rate would be jumping from roughly $1,890 a month to $3,222 a month within the span of nine months. And this isn't just a hypothetical possibility. News outlets have already started sharing stories about Canadians who were convinced they were making a fortune building investment for their future and now face the possibility of financial ruin as a result of their skyrocketing monthly payments.
The Variable Rate Variable: A Hidden Risk for Canadian Homeowners
Now you might be thinking, sure, that sucks for variable rate borrowers, but exactly how many home buyers opted for a variable rate? Well, in the last few years, the majority actually. You see, when rates are at the rock bottom levels during the pandemic, variable rates on mortgages were actually offered at a substantial discount to fixed-rate mortgages, with banks wanting to pass along the interest rate risk of these loans. And since home buyers had spent a decade in a low-interest rate environment, many assumed low rates would continue, which has led to one-third of mortgages in Canada to be variable rate. But wait, there's more.
In Canada, fixed-rate mortgages aren't really fixed rate either. Rates are only locked in for a period of typically five years or less, after which the mortgage rate resets based on the market rate at the time. That means that over the next five years, virtually every Canadian with a mortgage will see a financial impact from these higher rates. And while that's scary enough, there's one final quirk about Canadian mortgages that really highlights how devastating this can be for Canadian households. With the exceptions of Saskatchewan and Alberta, mortgages in Canada are recourse loans. This means that if you don't pay off your mortgage in full, lenders can go after your personal assets to make up the difference, even if you relinquish your house.
If prices continue to fall, Canadians who can't afford their high-interest payments may not be able to recover the amount from selling their house to pay off their mortgage, which won't decline in step, meaning they'll still be making payments on that difference even after losing all the equity from their prior payments. But if the prospect of your property falling in value below what you actually owe on your mortgage wasn't bad enough, it gets worse. Because some Canadians are actually seeing the balance of their mortgage increase. Three-quarters of variable rate mortgages in Canada are fixed payment mortgages, meaning that the borrower makes the same dollar payment each month regardless of what interest rates actually are. Fluctuating rates still impact the policy, but they simply change how much of the payment goes towards the principal versus the interest expense. If rates go down, the mortgage will actually be paid off faster. But if they go up, a larger portion of the payment will simply be going towards that interest expense instead of paying down the principal.
And when they go up as drastically as they did in 2022, they can reach what's called their trigger rate, where the fixed payment is entirely taken up by interest, and home buyers are no longer paying down their mortgage balance. And when rates go past this point, borrowers can either increase their payments, pay off a chunk of their principal, or if none of those options are available, apply the interest back to the principal, something called a negative amortization mortgage. And while this might sound like an impossible nightmare scenario, we've unfortunately already seen it happen. The Jordan estimated back in May that over three quarters of variable rate fixed payment mortgages had surpassed their trigger rate, a figure that's surely higher now given the subsequent rate hikes we've seen.
And more recently, three of Canada's big six Canadian banks disclosed that 20 percent of their mortgage portfolios consisted of negative amortization loans. So, yeah, that's how crazy things have gotten in Canada. But it does all beg the question, why haven't things crashed yet? With everything we've covered so far, you would expect that delinquencies in Canada would be skyrocketing right about now. Yeah, as of recording, the most recent delinquency rate for mortgages is near a record low at 0.15 percent. There are some possible explanations as to why this is the case, with one of them being that given the pyre stakes, many Canadians are trying to tough out the turbulence in hopes that things will moderate. You see, during the pandemic, Canadians actually built up sizable cash savings, with checkable and at notice deposits rising 40 percent between 2019 and 2022.
This has given Canadians a bit of a buffer to make these higher mortgage payments. There's also the fact that when it comes to fixed-rate mortgages, and even some of those variable rate ones, those payments obviously might delay a delinquency by not changing immediately, even if in some cases, it's actually extending the overall cost of the property to the buyer. Meanwhile, new listings are so far down from a couple of years ago, suggesting that those able to are waiting to sell. Even if demand falls, an in-step decline in supply could keep prices elevated. It all goes to show why it's so difficult to predict where prices will go in the short term. On the one hand, higher rates could go higher still, and for some, widespread deleveraging, with demand for properties, especially from the investor group, following listing surging prices for real estate declining.
And there's likely being a severe financial impact on the country, given that 21 percent of national wealth and 1.3 million jobs are tied just to residential investing. On the other hand, with inflation down from its peak levels, there's a chance we see more progress here, and that central banks actually consider cutting rates, which could be enough to alleviate pressure on buyers. Many lenders are also actively reaching out to borrowers to try and ease the contract terms and extend amortization periods. With Canada generally having more conservative lending practices, debt-laden home buyers may get whether the storm, with a Re/Max report highlighting the low loan-to-value ratios of Toronto and Vancouver and the shrinking percentage of buyers with credit scores under 660. In the report titled "Canada Housing Market Risk Low Despite Short-Term Contraction," they are a real estate agency, so do keep that in mind.
What is clear, however, is that the current trends, all taken together, are not sustainable, and the current housing crisis does face the risk of evolving into a financial one without meaningful government action and policy change. And regardless of the outcome, the situation is already hurting Canadians across the country. So far, we've only talked about aggregate statistics, but within that, there are a lot of people falling through the cracks. None of the typical stress tests applied to mortgages in Canada would have considered these surging rates we've seen. And while you can blame those falling behind on mortgage payments for buying into a hot market when they couldn't afford the surge in rates, most people aren't real estate experts. And not many people could have predicted the surge of rates we've seen. And given how much of real estate is commission-based, even those in the industry are, unfortunately, more incentivized to focus on generating sales than ensuring budget feasibility when it comes to buying a house. With many buyers being told that so long as you could get approved for a mortgage, it was worth buying a property, regardless of your situation.
Tips for Potential Homebuyers
So if you're considering buying real estate, especially your first property, you should focus on affordability and risk tolerance as opposed to financial gain. It's true that real estate can be a lucrative investment, and even with all these negative variables, prices could go up from here. But rather than trying to time your purchase for the next crash, worrying about missing out, or deciding to short the market for your first home, you should really focus on your personal wants and whether you can afford the payments and the volatility. The risk of payments going up. Home prices do tend to appreciate over the long term, but that won't matter if you can't afford things in the near term. I'll leave a link to a helpful resource from the Canadian Mortgage and Housing Corporation on home buying, but the one thing I'll point out from there is the recommendation that housing costs do not exceed 32 percent of your average before-tax monthly income.
But you should also consider your level of savings and other risk tolerance variables when buying a home. I'll also include a link to the "Home School" series by Global News, a set of articles targeted at educating new home buyers. So definitely go check those out. If you can't afford a property right now, you can consider a less densely populated area if your situation allows it, or you can park your money in other investments so it continues to grow while you wait. If you're really worried about missing the bandwagon, there are other investments, such as real estate investment trusts, that can provide you some real estate exposure without you needing to put your whole financial well-being at risk. And if you are currently experiencing strain from your mortgage, speak to a professional, whether that be a financial planner or advisor, a certified credit counselor, or a licensed insolvency trustee.
Also Read : 2024 Mortgage Rate Predictions
They can help you decide whether you should sell the property, hold through the turmoil, or consider other options. And to be clear, none of this is to suggest that dealing with the situation we find ourselves in will be easy. I haven't even talked about renters, who are likewise seeing the pressure of high real estate properties and high-interest rates on their monthly budgets. But at the personal level, there are things you can do to help better prepare yourself for whatever comes of the Canadian real estate market, whether prices continue moving painfully onwards, or we see a crash in real estate values. And if you're a Canadian who's bought a property in the last few years, I'd be very interested in hearing your story and what your thoughts are on all of this.