Canadian Real Estate Bubble Blowing Up North

(Photo by Arindam Shivaani/NurPhoto via Getty Images)

Canadian marijuana is not the only market on a roll in Canada. Arguably the most beautiful city in North America, Vancouver, British Columbia, is also distinguishing itself as home to a classic real estate asset bubble. The signs it will burst are popping up everywhere. So where is the investment opportunity?

According to the Real Estate Board of Greater Vancouver, single detached homes in Vancouver (on a local currency basis) have risen from approximately $400K CAD to $1.75 million CAD since 2002. That’s a 337% increase in 15 years. With incredibly fast rising prices, a large portion of the population is engaged in real estate brokerage, real estate development, construction, renovations, and everything that goes along with that. The echoes of Phoenix, Las Vegas, and San Diego from 2006 cannot be ignored.

The Austrian von Mises/Hayek theory defines speculative bubbles as a government increase in money supply (Global QE), resulting in unnaturally low interest rates. The reaction to manufactured lower interest rates results in entrepreneurs investing in capital intensive or durable goods versus consumer goods. Instead of capital flowing into what an unfettered market would dictate, it flows into speculative investments. The longer this continues, the bigger the speculative bubble. Just look at past bubbles and the theory holds true – stocks, bonds, real estate, art or even tulip bulbs.




So why does the majority of the local population believe that this time is different? They refer to Vancouver as geographically constrained (ocean to the west, border to the south, and mountains to the north) and believe that housing will only go higher and higher. However, the same can be said about many coastal cities (including NYC) who have experienced boom and busts through typical real estate cycles over the years. This time is NOT different and investors should be aware of the possible knock on effects of a large Canadian real estate correction.

Also, there are new catalysts that can’t be ignored. Taxation and interest rates are going higher. Cap rates on rentals or commercial properties are shockingly low (think 1-3% in most circumstances). In fact, Canada’s price-to-rent ratios are now well above what the U.S. was during the 2006 housing debacle. According to the Bank of Canada, 47% of Canada’s mortgages will reset in the next 12 months. To put that in perspective, a five-year fixed mortgage rate in Canada averages approximately 5.14%. This is 11% higher versus the 4.64% that it averaged for most of the past 2 years.


To make matters even more challenging, foreign investments in the Canadian real estate market is on the decline with China heightening its capital controls. Finally, the IMF warned that Canada, along with Australia and China, has extremely high personal debt-service ratios and are susceptible to shocks if imbalances grow further. Private sector debt to GDP is now 218% in Canada.

A real estate sign reading "Sold Over Asking" stands on display outside a townhouse in Richmond, British Columbia, Canada, on Sunday, Dec. 11, 2016. In August, the province of British Columbia imposed a 15 percent tax on foreign buyers, and in October the federal government tightened rules on mortgage eligibility. Those steps had some success in cooling the market -- but also sent a signal to developers and builders to slow down. Photographer: Ben Nelms/Bloomberg

Many U.S. hedge funds have looked for various ways to short the Canadian housing trade. Home Capital Group was the poster child and a successful short for those who played as the stock went from $56 CAD in 2014 to $7 in 2017. It currently sits around the $14 level. However, the Canadian capital markets have very limited and liquid direct ways to bet against the cycle. Consumer discretionary names in Canada may prove to be the most liquid way to gain negative exposure.

Looking at all the evidence in an objective way, I would caution investors to tread lightly and to take profits if they can. To paraphrase former U.S. President Reagan, “If you own a house, sell it. If you are thinking of buying a home in Vancouver, wait. If you think this time is different…..good luck to you!”

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