Canada’s housing market held up surprisingly well during the economic crisis in 2008, especially compared with other nations. While home prices in the U.S. fell dramatically, our real estate prices remained strong with good sales and growth. However, our market remains vulnerable. Ultra-low interest rates continue to drive prices up and now experts say Canada’s real estate market is also overheated. They add Canada is ready for a correction as dramatic as 20%-30%.
This news, along with a slowdown in sales over the last 12 months and plateau in prices, is encouraging some investors to 'short' the Canadian housing market. Those investors are hoping home prices will come down and they will make money. Although mega-common in the U.S. Canadians have not been victim to short selling and underwater mortgages. However, some investors have hedged against our market, and they stand to make millions if the Canadian market softens.
What Is Short Selling?
When you “short” an investment you are betting its price will fall in the future. To short an investment, a broker or agent lends you a stock/equity/commodity at today’s price, with the promise to buy it back at that price on a predetermined date. If the price falls you make money, if it rises they make money. That’s the simplest way of putting it. Investors can do this with whole markets, like Canadian real estate. By selling the Canadian real estate market at today’s price to someone in the future, investors are hoping the market will soften and prices will come down so they can profit off the losses.
New Mortgage Rules And A Cooling Market
Finance Minister Jim Flaherty has seen some success in his attempts to reign in the hot housing market. He made a number of announcements in June 2012 that included limiting amortizations to 25 years from 30 for high ratio mortgages (those with less than 20%, discontinued insurance on homes worth more than $1 million, and limited the maximum loan to value ratio on refinances at 80%, from the previous 85. These measures are also contributing to the slow down in housing sales activity in Canada.
Why Do Experts Think Canadian Prices Could Fall?
Canada’s home prices have remained relatively strong over the last 10 years. This is driven mainly by record low interest rates but also by flexible mortgage rules that have allowed lower income earners to purchase a home. With interest rates poised to rise next year and mortgage rules being tightened up experts say home prices will likely start to come down as demand for real estate will start to taper off.
What Happened in the U.S Housing Market?
In the 10 years leading up to the housing collapse in 2007/08 U.S. home prices were artificially inflated. They were being driven up by relaxed lending practices that were allowing those with minimal income and bad credit secure huge loans. These borrowers went out and bought massive homes they could not afford with the perception that home prices would continue to rise. When prices came down as dramatically as they did, many were left with very little value in their home and no choice but to give the house back to the bank for whatever price it decided to buy it back at. Those who had the foresight to hedge against the success of the market made a windfall.
Could This Happen In Canada?
There are sufficient controls in place in Canada to prevent a U.S.-style housing collapse (where, in some places values fell 80%). That said, Canadian homeowners currently hold record amounts of debt and home prices are near record highs. A correction in the real estate market could result in the worst downturn Canada has ever seen. The biggest concern is those who have high ratio mortgages, meaning they've paid for less than 20% of their, could be faced with the fact that they owe more on their house then it's worth, referred to as an 'underwater mortgage'.
Can Speculation Drive Prices?
Absolutely! Speculation is the beast that drives markets. Investors are always betting something will happen and hoping to be on the right side of the investment when it does. It’s usually speculation, not real proof, that creates panic and causes markets to swing in both directions. The U.S. Housing market bubble was driven by speculation that prices would always go up. Right now, there is a bearish tone in the Canadian real estate market and that negativity is being fueled by the fact that home price have started to taper off.