Is Canada in a real estate bubble?

Ashleay: Welcome to the “In Your Interest!” podcast. My name is Ashleay and this week we're answering the question “Is Canada caught in a real estate bubble?” So, hello Sébastien.

Sébastien: Hello Ashleay.

Ashleay: As always, great to have you back on the podcast today.

Sébastien: Very happy to be here.

Ashleay: We've been hearing about how residential real estate in Canada is in a bubble that is in danger of bursting for almost 20 years now. And some politicians have recently even put the issue back on the public agenda. The question is, are we really facing a bubble?

Sébastien: The short answer is that we don't think so. We don't think that this is a bubble. And the topic, as you said, has been on everybody’s mind for 20 years—and even more so outside of the country. So when foreigners are looking at Canada, they're saying, “well, something fishy is happening here.” But when you do the homework, you realize that there's a very specific reason why housing is behaving like it is. And the answer has a lot to do with Canadian demographics. But before we move to the explanation, I just want to say that I have an issue with the use of the word bubble around housing. If you consult the dictionaries to see the definition of a speculative bubble, what you find is that a speculative bubble occurs when the price of an asset rises excessively beyond its fundamental value. So it's easy to think that because prices have been up, up, up, it’s a bubble. A bubble typically appears when a good is fueled by speculative behavior: economic agents like investors become overoptimistic about a theme; they start to anticipate that the prices of this asset or these assets will continue to rise; they invest in the hope of reselling in the short run at a higher price and making a profit. When a bubble bursts—and we've seen multiple bubbles burst—on average, the price tends to fall by about 70%. When a bubble bursts, you have real economic pain. And just, for example, with the tech bubble of 2000, the peak for the Nasdaq was on March 27, 2000, and the bottom was on October 7, 2002. So over, about two and a half years, the price of the Nasdaq fell by 83%. So it's not just a speculative thing; this is an index that serious investors play in. When a bubble bursts, you get this kind of damage: losses of something like 83%. Irrational behavior causes bubbles, although it's usually genuine economic fundamentals that just kickstart the movements. Like if you went into a time machine today, going back to the mid-1990s and heard someone say, “Well, I think the internet is going to take over the world,” you would know for a fact that they were right on that call.” It’s the enthusiasm that happened after, the good news that became priced in very quickly that pushed prices too far. And at some point there needs to be a fall back to earth. The same thing happened with the railroads in England in the 1840s. So American real estate in the 2000s with artificially low interest rates to bolster the US economy in the wake of the 2001 recession, with financial deregulation, etc.; it was a different story there. But here in Canada right now, when we look at the fundamental value, we see that demographics is playing a very important role.

Ashleay: But prices have gone up a lot all the same. Should people be worried?

Sébastien: Of course, prices have gone up and we should be worried about the few things. We should be worried about the home ownership issues for young people/non-owners. Access to property is becoming an issue. There are some intergenerational inequity factors there that are very important. But just because prices are going up doesn’t mean it’s necessarily due to speculation. We did some work on the topic and we published a report late last year—late 2022—on the iagam.ca web page. You can find that report along with the charts, analysis, etc., there. This report was in reaction to interest rates rising through 2022: housing prices having benefited from low rates during the pandemic, and we were asking the question, “how far can prices fall from here?” We expected a reduction between 15 and 30%, as interest rates rose. So it's not that we think that prices never go down; it's just that we don't think it's a bubble, because when a bubble bursts, again, prices drop by 70% and we don't think we’re there. In fact, we were a bit too pessimistic on that call because prices only fell by 11% and has already almost rebounded to all-time highs. What we found in our studies is that demographics are the central factor here. Demographics have a huge impact on the Canadian economy. Right now, Canada's population is growing at a rate of over 3% , which is the highest since the baby boom of the ‘50s and ‘60s. Well, if you look around, you’ll notice that there is no baby boom going on. This is mostly immigration: more than 80% of the demographic growth in the country comes from immigration. And when we look at the immigrants coming here, we know that within the OECD (so among developed countries), we attract the best educated or most educated immigrants. Nearly 70% of the immigrants that come to Canada have a post-secondary diploma in hand; they have assets; we integrate them very well into the labour market. The employment rates for immigrants in Canada is among the best in the OECD. And we lead the way in immigrant home ownership: nearly 70% of the immigrants, after a few years in Canada, own their own home. So in short, it's mostly demographics. Like I said earlier, a bubble is when you have a divergence between the price and the fundamental value, well the fundamental value here is led by the demographic factor.

Ashleay: So I feel like I'm the devil's advocate here. But even so, we hear stories that sound like speculation and prices have risen rapidly during the pandemic. Are there really risks? I feel like we have blinders on right now.

Sébastien: No, you're completely right. There are always risks and it's important not to wear rose coloured glasses. The potential for slippage remains high, and that's why it's important to understand the nature of the beast here. Canadian newcomers tend to converge on major centres like Toronto, Montreal and Vancouver. It's in these metropolitan areas that prices are under the most upward pressure. Elsewhere in the country, price increases have been much lower. For example, in Quebec City (where we're based), the unemployment rate is the lowest in the country, in the region, and even thought it’s been like that for the last decade, no price increase on average was reported between 2013 and 2020. Of course, it depends on the neighborhood and the type of home. But in aggregate, the growth in the resale price of houses in the region of Quebec was 0% for this period. Now, it's not like the Canadian market is no such thing: There's Toronto, Vancouver, there's Montreal, and then there's the rest of the country. Lower interest rates from 2020 to 2022 pushed the craze to new heights. So prices did rise, but the increase in the last 18 months seems to have some bite. And again, this is kind of a clash of the titans that we’re seeing here. Remember that when interest rates are low, housing prices tend to go up; and when interest rates rise, housing prices tends to fall. So you have this factor, but you have the demographic factor on the other end that is coming in the opposite direction and now the clash of the titans seems to be clearly won by the demographic factor. And just to look forward and to end on another statistic, here: looking at the current rate of population growth, the pace of new housing construction in this country—just to accommodate all of these new immigrants—would have to more than double. So a quick calculation suggests that you would have to double the construction workers in this country—and there's 1.5 million construction workers—just to balance supply and demand. This doesn't suggest that prices are about to crash; quite the contrary, we should continue to see some more upward pressure year in year out on housing. And in the long run, again, I'm more worried about the social issues surrounding access to property than about a bubble: we would need to see a mass exodus from this country for a scenario like that to happen, and it's not something that we foresee.

Ashleay: Wow. Well, thank you very much. Very interesting topic. Sébastien, you are awesome; thank you for your expertise. And for our listeners, don't forget to subscribe to our podcast so you don't miss any future episodes. We’ll see you next week! Love this podcast? Want to know more about economic news? Follow our “In Your Interest!” podcast, available on all platforms. Visit the economic news page on ia.ca or follow us on social media.