When will the Vancouver real estate bubble burst?

Hilliard MacBeth thinks it might happen soon—and that it won't be pretty when it does

February 3, 2016

By Max Fawcett

In a recent report, the Canada Mortgage and Housing Corporation indicated that there were “problematic conditions” in some of Canada’s major housing markets. But make no mistake: Vancouver was not one of them. Indeed, as BTAworks underscored in its latest update on property values in Vancouver’s single family housing market, things just keep getting more expensive in a place where they were already breaking records for unaffordability. Main Street, the unofficial line that used to demarcate Vancouver’s million-dollar neighbourhoods from the ones where detached houses still could be had for less than seven figures, now separates the homes worth in excess of $2 million from the ones that are merely a million and change. And you thought you were priced out of the market last year.

But while it’s tempting to think that this is some kind of new normal, there are still a few people left who believe that this is a bubble that’s just waiting to burst. Hilliard MacBeth, a portfolio manager at Richardson GMP in Edmonton, is one of the noisiest, and in late 2014 he published his thoughts in a book called When the Bubble Bursts: Surviving the Canadian Real Estate Crash. And while his call that the Canadian housing market would begin to collapse last summer hasn’t been borne out here in Vancouver, he thinks it’s only a matter of time before he’s proven right. “All bubbles burst,” he says, “and spectacular bubbles like the one in Vancouver burst in a spectacular fashion. It’s inevitable that there will be a correction.”

He’s not alone. As the Globe and Mail reported last summer, Marc Cohodes—a retired U.S. hedge fund manager who lived in California raising chickens on his farm—believes that the combination of “money laundering, speculation [and] low interest rates” has created a bubble in Vancouver’s housing market that was similar to the one that nearly took down his own country’s economy. In December, he told the Province’s Sam Cooper that 2016 would be the year when that bubble finally burst, thanks in part to ever-expanding price-to-income multiples and in part because of the decision by the CMHC to tighten up the eligibility for mortgage insurance on high-priced homes. “When you take the booze away after a 10-year party there will be a magnificent hangover,” he told Cooper. “So I think 2016 will be a debacle.”

If it is, it won’t just be because prices have risen so high. It’s also because Vancouverites have piled on eye-watering amounts of debt in order to pay them. “The difference with this cycle is that there’s so much more debt around than there ever has been in the past. The debt levels in the Vancouver market are—at least for the local residents—much, much higher than anything that ever happened in Hong Kong in past booms.” And, as he points out, those past booms in Hong Kong’s housing market haven’t tended to end well for people who got in late. “There’s no way it doesn’t end badly.”

Indeed, it’s already ending badly for those who invested in the latest property boom in Hong Kong, whose apex appears to sit squarely in the past. As Bloomberg’s Frederik Balfour noted in a piece on Monday, “the estimate that transactions reached a 25-year low in Hong Kong shows how quickly sentiment has turned.” Home prices, he reported, are already down 10 percent since September, while monthly sales figures are the lowest they’ve been since 1991. It could get worse, too. “Amid a spike in flexible mortgage rates this month and anemic demand for new developments,” Balfour wrote, “the low transactions volume for January is the latest evidence that prices have further to fall.”

How far could prices fall back here? MacBeth thinks that the national peak-to-trough decline could be in excess of 40 percent, with Vancouver’s drop being even bigger. “Every bubble bursts, and they all burst to the degree that gets the prices all the way back to the original trend line that was in place before the bubble formed. If we assume that this bubble started to form in 2000 or 2001, then house prices would have to go back to that trend line.” And while such apocalyptic forecasts are countered by claims that “it’s different here,” MacBeth isn’t buying it. “The price gains in Regina, Saskatchewan, have been just as outrageous as Vancouver, British Columbia. The price to income ratios aren’t as stretched, but the percentage gains from ten years ago are just as big. And I don’t think there are that many Asian investors buying housing in Regina.”

This is bound to elicit skepticism, given that people have been describing Vancouver’s housing market as being a bubble—and calling for its imminent bursting—for the better part of a decade. It has endured a global financial crisis, a post-Olympic hangover, and ever-rising levels of household debt and price-to-income ratios without showing even the slightest inclination toward collapse. So why would that change now? MacBeth doesn’t think it’s going to be the result of a single factor. Yes, he thinks that the Canadian economy might be headed into a recession and that Vancouver could be side-swiped by that. And while the Bank of Canada continues to hold down interest rates in the face of that weakness, the bond market—where mortgages are ultimately financed—is already beginning to raise the cost of capital for borrowers. “One of the reasons why Canada has gotten away with lower interest rates is because the currency is viewed as a safe haven. But if we’re to lose that safe haven status, which I think is what’s happening, then they’ll demand a higher interest rate than the U.S. Wouldn’t you rather have a strong currency in the U.S. dollar and a 1.5 percent interest rate than a weak currency and a lower interest rate? If that happens, then the bond market will move the rates even though the Bank of Canada doesn’t want the rates to rise.”

Meanwhile, MacBeth thinks that the carnage that’s unfolding in Alberta’s housing market is almost certainly going to leak west across the Rockies. Because so many of their loans are starting to go sour in Calgary and Edmonton, Canadian lenders—the big five banks, basically—may have to cut back on their lending in other markets in the country. “It’s totally unfair, but this has happened so many times in the past. People that are actually in good shape financially and have good collateral and all that kind of stuff, they find it’s harder to get a loan because the banks screwed up in Alberta.” But, he says, the market may not even need a specific catalyst in order to start questioning the valuation on Vancouver real estate. “Some bubbles in the past have burst and there never was a catalyst identified. Everybody could wake up one morning and for some reason decide, independent of each other but roughly at the same time, that it’s crazy to borrow $800,000 to buy a modest bungalow in Vancouver.”

Who would be hit the hardest, and hurt the most, by a crash in Vancouver’s housing market? Generation X, according to MacBeth. “My research found that they’re very much into housing—more than 70 percent of them own a house—and they’re very heavily indebted in the process. They have very little savings in RRSPs and TFSAs, and whether they were told or whether they just came to believe it, they bought a house thinking that it would be their savings vehicle—pay down the mortgage and that would be their retirement fund. Those people are most at risk.”

The winners? Millennials who have yet to pull the trigger on a home purchase of their own, and those who were prudent enough not to borrow every last dollar their bank was willing to lend. “It’s a funny trick of mathematics, but if you bought the $500,000 place but you could afford a million-dollar place and prices go down 30 percent, assuming that deduction applies equally the spread is narrowed by $150,000. Now you’re selling at $350,000 house and buying a $700,000 one. Psychologically, they might not be as excited about moving up, because nobody likes to sell at $350,000 when they bought at $500,000. But if you ignore that, and assuming they don’t get screwed up with their mortgage, they could move up much more easily.”

Still, he says that’s a silver lining that few will be able to appreciate, and fewer still will actually act upon. And while boomers will have enough equity in their homes to survive even the nastiest downturn, those who bought more recently won’t be nearly as fortunate. That’s why, he says, they might want to consider getting out now—before it’s too late. In the end, after all, it might turn out to be the Boomers who end up popping the very bubble they’ve helped inflate as they downsize into smaller places and harvest their capital gains. “There isn’t enough of them [Gen Xers] to buy the houses that all of the Baby Boomers are going to want to sell when they start selling. And they have already started selling.”

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