Stephanie Clark does not want to leave New Westminster, a town about 45 minutes south-east of Vancouver where she was born and raised and, two years ago, had a baby. But she fears she will have to, driven out by a property market that seems to have lost touch with reality.
The two-bed condominium she bought for C$259,000 in 2015 was revalued last year at C$490,000 ($391,000), meaning higher annual property taxes to pay and larger maintenance fees. Friends of the 35-year-old web co-ordinator who rent their homes live in fear of “renoviction” — landlords turfing tenants out under the guise of refurbishment, then ordering them to pay much more in rent if they want the place back.
Canada is in the grip of a housing crisis more severe, by some measures,than anywhere else in the world. Household debt now amounts to more than 100 per cent of the country’s gross domestic product, according to the Basel-based Bank for International Settlements, one of the highest of any developed nation. House prices have raced ahead of wages for years, boosted by loose lending, low interest rates and lax controls on foreign money.
Ms Clark says there are parallels to America a decade ago, when defaults in the subprime mortgage market tipped the country into its worst recession in a century. “I remember thinking when all that stuff went down [in the US], ‘you could never get approved for that kind of thing up here’,” she says. “It’s frustrating to see it happen.”
For now, the number of home loans in arrears across Canada is still very low, suggesting that people are finding ways to cope with ever-larger debts. But rising interest rates are beginning to bite, while a new stress test for mortgages issued by regulated banks has tightened the supply of credit. This week the Toronto Real Estate board said that sales in Canada’s biggest city dropped 22 per cent in January, the weakest for that month since 2009.
Bearish analysts have long argued that Canada’s housing market has a date with disaster. But even people within the industry are wondering if a full-on collapse can be averted. “I don’t know how this all shakes out, but based on the amount of household debt we have, and the way prices have gone up . . . a strong gust of wind could send us down a pretty scary path,” says Steve Saretsky, an agent based in Vancouver.
Bullish observers say fears of a meltdown are overblown. Canada can sustain high house prices, they argue, because they reflect the country’s high levels of net migration, restrictive zoning laws and low unemployment.
Henry Lotin, a retired diplomat and principal at research group Integrative Trade and Economics, says the same forces that have pushed up prices in global hubs such as New York are now doing the same to the most attractive parts of Canada. “Torontonians should be thankful and we should manage it as best we can. We really have to be prepared that demand is going to exceed supply for the foreseeable future.”
Many also note that mortgage books at the big banks look rock-solid. Royal Bank of Canada, for example, which recently joined the club of the world’s most systemically important banks thanks to years of rapid asset growth, had a Canadian residential mortgage portfolio of an average C$231bn in the year to October. Defined as estimates of losses on impaired loans and losses incurred but not yet identified, provisions for credit losses were just C$33m — or one one-hundredth of 1 per cent.
Others say pristine loan books are not a good indicator of the stress lurking in the system. For one thing, every homebuyer with a downpayment of less than 20 per cent of the purchase price (if less than C$1m) has to buy insurance against default. That has the effect of flattering the banks’ books but shifts the risk of default to insurers such as the state-backed Canada Mortgage and Housing Corporation.
CMHC was set up after the second world war to help returning veterans find housing. These days it insures about C$480bn of residential mortgages, or almost one-third of the outstanding stock in Canada, using an automated system to process about two-thirds of applications.
Meanwhile, the uninsured segment is growing. As the market has barrelled upwards in recent years, borrowers have been able to convert insured mortgages into uninsured mortgages simply by buying a property, waiting for the price to rise, then refinancing.
Uninsured buyers made up about three-quarters of new loans at federally regulated banks in 2017, up from two-thirds in 2014, according to the Bank of Canada. In Vancouver, where the average sales price of condos hit a record of C$1.1m in January, more than double the level a decade earlier, about 90 per cent of new mortgages are uninsured.
Laurentian Bank, Canada’s seventh-biggest by assets, said in December that it would have to buy back about C$300m of mortgages it had sold to third parties, having found that borrowers had “embellished” income and assets. Last month, the Montreal-based bank said the buyback obligations had increased to about C$400m, and it would have to raise more capital.
That kind of disclosure — in dribs and drabs, each more alarming than the last — has echoes of the beginning of the US mortgage crisis, when terms such as “liar loan” began to enter the vernacular. “Trends are developing . . . that we took for granted were not an issue in Canada,” says Gabriel Dechaine, an analyst at National Bank of Canada. “There are puffs of smoke, but I don’t want to yell fire in a crowded theatre.”
Canada residential property in numbers
75%
Portion of new loans that were extended to uninsured buyers from federally regulated banks in 2017, according to Bank of Canada
>100%
Household debt as a proportion of Canada’s gross domestic product, according to the Bank for International Settlements
C$2.4bn
Financing package provided by Warren Buffett to stricken mortgage lender Home Capital last year
More strains could emerge. With interest rates rising — three increases in the central bank’s policy rate since July has left it at 1.25 per cent — many borrowers may be facing a struggle to refinance in a market where almost all mortgages are renewed every five years or less.
“Good luck to anyone renewing a mortgage at a significantly higher rate,” says Marc Cohodes, a California-based short-seller who has waged a long campaign against Home Capital, Canada’s largest provider of home loans to the newly arrived and self-employed. Shares in the Toronto-listed company plunged last April after the Ontario Securities Commission said it failed to give a proper account of a rash of fraudulent mortgages in 2015.
Mr Cohodes is still betting on further falls in the stock, even after Warren Buffett’s Berkshire Hathaway provided a C$2.4bn financing package in June. At the time, figures such as Bill Morneau, the country’s finance minister, and Bank of Canada governor Stephen Poloz described Home Capital’s problems as “contained” and “idiosyncratic”.
“It’s exactly the same language we heard when New Century went,” says Mr Cohodes, alluding to the April 2007 collapse of America’s biggest independent subprime lender. “Instead of saying ‘it’s a problem, it’s a blemish, we’ll deal with these bad actors swiftly and severely’, they try to shuffle it under the rug and pretend it’s a one-time deal.”
Anecdotal evidence suggests tougher rules on underwriting are also beginning to curb lending. On January 1 the federal banking regulator, the Office of the Superintendent of Financial Institutions, introduced a rule requiring all new mortgage applicants to show they could cope with interest rates substantially higher than their contracted rate. Previously, stress tests applied only to insured mortgages.
The higher bar is “definitely making it more difficult” for people to get loans, says Scott Ingram, a property agent at Century 21 in Toronto.
The tightening of credit could be a “tipping point, when senior people at the banks realise they’re making loans unlikely to be paid back”, says Hilliard MacBeth, an Edmonton-based investment manager and author of the 2015 book When the Bubble Bursts: Surviving the Canadian Real Estate Crash. The question now, he says, is how the banks react. “Do you go cold turkey or gradually wean yourself off the drug?”
If the federally-regulated banks keep turning people away, activity is likely to be pushed into the margins, where lending standards are looser. Canada’s shadow banking system was more than half the size of the traditional one in 2016, according to Bank of Canada estimates, with about C$1.1tn in liabilities.
Much of that is in home loans. Bank of Canada’s official numbers show that non-banks — trusts, credit unions and other financial institutions — held C$313bn of residential mortgage credit in December.
A good chunk of the alternative lending goes through mortgage investment corporations — private, provincially-registered vehicles selling shares to the public to buy pools of mostly short-term home loans. One of the big MICs is Ryan Mortgage (slogan: “Tired of the stock market rollercoaster?”), a fund with C$260m in assets. It boasts 10-year average annual returns of 9.41 per cent.
Then there are private, bilateral deals, typically set up by real estate brokers freelancing as peer-to-peer lenders. A typical transaction might see a homeowner taking out a home equity line of credit (HELOC) at a 4 per cent rate of interest and then lending to a subprime borrower at, say, 10 per cent. That borrower then looks to refinance after a year or so, having built up enough equity for a conventional mortgage.
Harold Gerstel, a jewellery buyer in the Toronto neighbourhood of Forest Hill, set up a sideline in mortgages using “friends and family money” in 2013. One of his TV advertisements describes first, second and third mortgages in “five business days, no income statements necessary. Bad credit? No problem!”
He says volumes have risen about a fifth under the new OSFI rules. “The housing market is crazy high so even people making relatively good salaries have a hard time getting first mortgages.” He says he normally caps loans at about 80 per cent of the value. “Like an aeroplane, sometimes you hit turbulence, but the key in this thing is not to get carried away and not to over-lend.”
Are regulators on top of this? Hardly, says Ben Rabidoux, president of North Cove Advisors, a Toronto-based firm which advises institutional investors.
Last month he scored a victory, after the Financial Services Commission of Ontario cracked down on four brokerages that raised private funds for a condo and townhouse developer known as Fortress Real Developments. Mr Rabidoux had argued for years that the agency needs to take action, warning that “mom and pop” investors were putting money into investments marketed as safe and secured against real property, when in most cases they involved risky unsecured equity financing with no direct collateral coverage.
He says the sanctions on the brokers — fines of $1.1m, plus banning orders for four individual brokers — were too little, too late. In a letter to the FSCO last week, seen by the FT, he said “a fifth grader” could have seen that small investors were being exploited. The FSCO was not available to comment.
As for Ms Clark, she is beginning to despair. This week she sent an open letter to the mayor of New Westminster about a huge new high-rise development, saying that it would force more families into small condos out of necessity rather than choice. The letter was a big hit on Facebook. She now wishes she had gone direct to the government of British Columbia, or even to Ottawa.
“I had no idea it would be as far-reaching,” she says. Writing it “was an emotional reaction to coming home one night and seeing no place to park, and no green space around us. It feels like things are getting worse and worse.”
Overseas cash: Call for tighter controls reflect fears over market
Judy Wang and Peter Zhang arrived in Canada eight years ago with about C$6m to their names. Within a few years the Chinese couple had built a portfolio of detached homes in Toronto while Mr Zhang had racked up huge losses on the baccarat tables at the Casino Rama resort, an hour outside the city. One property deal went sour and Ms Wang, now divorced, sued half a dozen associates, according to court filings in Ontario.
The proceedings came before Paul Perell, a superior court justice, in October. In his ruling he wrote that the non-English speaking pair could not explain how they sustained themselves in Canada. He also noted that the defendants believed Mr Zhang had moved his money from China to become a money launderer in Canada. “I make no finding other than saying that it is unknown how Ms Wang and Mr Zhang acquired their considerable wealth or how they got it out of China,” he wrote.
Canada has long been open both to migrants and overseas money. Ms Wang and Mr Zhang were both beneficiaries of the federal immigrant investor programme which welcomed experienced business people with a legally obtained net worth of at least C$1.6m. It was scrapped in 2014 but every province now runs similar schemes.
It is time for tighter controls, says Alba Arboleda, a California-born technology consultant who moved to British Columbia in the mid-1990s. She is angry at developers pre-selling their high-rise developments offshore and then allowing units to be flipped three or four times for higher prices before a cent is paid in taxes.
As for the thousands of immigrants arriving each year with sacks of money, “it doesn’t really matter if they’re from China or Zimbabwe,” she says. “It’s people not really joining society, totally skewering the market.”
Letter in response to this article:
Housing bubbles always make mortgage books look good / From Alex J Pollock, Washington, DC, US
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