Is a Real Estate Correction Coming?


Housing prices in Canada have been a topic of conversation for some time. Anyone that owns real estate likely has their own opinion as to what real estate is worth today and more importantly what it will be worth a few years from now. As prices have risen in Canada the expectations of a “correction” or a “crash” have risen, but sometimes such talk should remind us to examine why house prices have reached current levels in the first place and if those factors could change going forward.

To provide some insight we came across a speech by Lawrence Schembri, Deputy Governor of the Bank of Canada, which he made to the Canadian Association for Business Economics last month. Some of his comments and conclusions are quite simple really, but sometimes a refresher of the simple conclusions can remind us to stop searching for the complex answer.

Looking at the Canadian real house price index he makes a simple observation – there was no material upward trend in housing prices from 1975 to 1995; however, a trend has emerged since 1995 and continues to rise. He also notes that real house prices have increased globally over that time period (not just isolated to Canada). So to understand why this trend has emerged and why it continues to grow, he provides a few explanations:

  • Macroeconomic – rising disposable incomes and lower long-term interest rates. It’s fairly simple to understand that as incomes rise, asset prices will tend to increase as well. However, I’d put greater emphasis on the lower interest rates in particular which has made mortgages relatively less expensive than what they were back from 1975 – 1995. This is why many buyers of real estate today don’t believe prices will come under pressure until interest rates reverse course. While we can’t say housing is more affordable today in some markets, the credit used to purchase housing certainly is.
  • ​​Demographic – population growth. Could we not just build more houses to offset the growth and keep prices stable? This would be much easier if we could spread housing easily across undeveloped land, but the reality is that most of the additional population from the past 20 years has found itself living in cities and we’ll touch on urban density momentarily.
  • Credit conditions – Broader access to and more efficient funding of mortgage credit due to financial liberalization and innovation. Banks have always been an option for financing historically but there are other options at your disposal today. As Schembri notes “a broader set of borrowers and lenders has become involved in obtaining and providing mortgage financing”. The more options there are, the higher likelihood that more Canadians will get access to mortgage financing and thus more housing transactions are consumed.
  • Rising urban density combined with regulatory and geographical constraints -  You might not think about this factor as much, but it’s certainly influential. Even with the massive condo boom in Toronto over the past decade, the city is still finding space for condo development, but not necessarily for single-family homes which might explain why price growth in single-family home prices has been greater as density has increased. Vancouver has increasing density but also has geographical constraints as you can’t build homes in the Pacific Ocean (although if it were Dubai, I’m sure they’d try). This factor in particular reminds us that real estate prices are heavily influenced by location, location, location…
  • International investment -  Speaking of Vancouver, never forget that real estate is a global market and that money flowing into Canadian real estate is not always Canadian. Prices can seem expensive from a Canadian perspective, but if our real estate is viewed as inexpensive from a global perspective then we’ll certainly attract foreign buyers.

We would note that Schembri did highlight two vulnerabilities to rising home prices: 1) higher real estate prices could translate into higher personal debt levels and 2) asset price misalignment, which is essentially another way of saying “speculation”. He notes that the Bank of Canada monitors these two vulnerabilities closely.

So the magic question of course is where are prices headed in the future? Or at least what might cause the upward trend in prices to stall or fall. Well let’s look at the explanations above and ask whether or not these could change. Probably the most influential and most likely change would come from macroeconomic conditions. Disposable incomes are not guaranteed to rise and we all know that interest rates will increase eventually which will soften demand. While population growth could slow, we will continue to see most of that growth in urban rather than rural areas of the country which will keep urban density and geographical constraints in focus.

As for international investment, this could change for a number of reasons such as relative global valuations, repatriation of foreign funds, a global recession, etc. These trends tend to be cyclical and can be drawn out over many years. After all didn’t the Japanese own a lot of real estate in North America back in the 1980s and 1990s? Where is that ownership now? Changes are inevitable, it’s just how the market/consumer reacts to those changes that will dictate the direction of home prices going forward.

Our summary of Mr. Schembri’s speech is in no way exhaustive as he discussed many other topics and provided far more detail. We simply wanted to review some of the key factors driving the housing market, noting why they exist and if they could possibly change. If you’re interested in the Canadian housing market and would like to read Mr. Schembri’s speech in its entirety, please click here for his presentation.




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