Will Canada’s Real Estate bubble Eventually Burst?

With sales data up again this month, Canada’s real estate market is a rare economic highlight. But how long can this be maintained?

The thing about bubbles is that you can almost always tell when they’re about to pop. There’s an extra shiny, bright quality to the surface and the edges start to pull up into the middle. And then, it bubbles over.

There’s not much question that Canada’s residential real estate market has displayed all the classic symptoms of a bubble that’s about to burst for some time now. And yet, every time it looks almost certain to burst, it stabilizes and puffs up a little more.

Sure enough, the latest data released from the Canadian Real Estate Association indicates that the resale of existing homes was up by 1.2 per cent in October over September (which posted a 2.5 per cent gain from August levels) and overall, by 8.5 per cent over October 2010.

In a month crammed with bad economic news on every front, Canadian residential real estate went and posted its best performance since January.

Even more remarkably, the strength of the market in Ontario — a province that has been ravaged by its battered manufacturing sector and a jobless rate that climbed to 8.1 per cent that same month from 7.6 per cent a month earlier — strongly propelled the national housing market forward.

The same data scoop shows that the national inventory of homes for sale is well balanced, allowing residential housing prices to increase by 5.5 per cent.

On average, residential real estate prices in Canada are 10 per cent higher now than they were before the recession — when they were at an all-time high.

Not too shabby — especially if you consider the rate of return available from stocks or bonds these days. But at a time of profound financial uncertainty (globally, continentally and nationally), rising unemployment (Canada unexpectedly lost 54,000 jobs in October, pushing the unemployment rate up to 7.3 per cent), record household debt and flagging consumer confidence, how shiny and tight is this all going to get before there’s a loud — and familiar — popping noise?

An equally important question is what are the implications of a loud popping noise for the all-important rate of consumer spending (homeowners buy furniture, appliances and services in spades) and a number of economic sectors that have been fuelled by the real estate cycle.

As we face another economic downturn, it’s important to remember what an important role real estate-related spending played in the recovery — however short-lived. After a brief slump, the Bank of Canada’s decision to cut interest rates fuelled growth and the relatively healthy condition of the Big Banks kept mortgage lending alive.

The results rippled throughout the domestic economy.

Canada’s construction business, by way of just one example, has been the second-fastest growing sector for the past decade and accounts (directly and indirectly) for almost a million jobs.

Still, according to several bank reports (brought to you by the people who really, really want the domestic real estate market to hold together) the upward pressure on prices and transactions will ease in 2012 and 2013. And that will cool things down sufficiently to avoid a dramatic implosion.

Other than a deeply vested corporate desire to avoid a real estate market meltdown, what’s the rationale for that view

The first and most obvious factor is interest rates — or more specifically, the Bank of Canada’s assurance that given the miserable state of various economies, interest rates aren’t going anywhere in the foreseeable future. As a result, mortgage rates will continue to linger at historic lows.

In turn, that suggests that housing affordability and demand will be stable, although slightly stagnant. After all, given variables like confidence and employment, buyers are likely to be more cautious and less likely to drive up prices.

Another cooling influence is that lenders are more cautious this time around and the Canada Mortgage and Housing Corporation cracked down on easy mortgage terms in mid-2008.

The real risk would be if the value of homes continues to increase faster than incomes. According to Bank of Montreal economists, average home resale prices compared with personal incomes are 14 per cent above the long-run trend, although they’re still below the 21 per cent peak that preceded the 1989 crash.

Furthermore, lower interest rates have made bigger mortgages possible, which has — of course — driven up prices. As a result, BMO calculates that mortgage payments for the typical owner consume 35 per cent of disposable household income.

The widespread use of home equity lines of credit — which almost 40 per cent of Canadians now have, doesn’t bode well either if real estate markets are rocked by a sudden interest rate rise or other variable.

It’s likely that real estate will be shiny and tight for the foreseeable future, bearing in mind it’s possible for bubbles to deflate without bursting.

With real estate, the stakes are high politically (home-owning voters are happy voters), corporately (sound mortgages make sound banking profits) and internationally (Canada is enjoying its international status as a fiscally prudent nation). That means the chances are better-than-average that, to the best of their ability, policy makers and others will micro-manage this file.

So that just leaves their ability in question.

MSN Money November 21, 2011