It was all about to come crashing down.
That’s the conclusion one would draw from reading the Canadian business press in the spring of 2017, which, after giddily cheering the housing boom, now heralded an inevitable bust.
A favourite theme: Canadians appeared to have lost their minds over houses the same way their American cousins had ahead of the financial crisis of 2008. Nondescript detached homes in hard-luck Hamilton, Ontario, were selling for $1 million. In Vancouver, prices had climbed 50 per cent in only three years heading into 2016 — great if you happened to own property, not so great if you didn’t. Institutions such as the Bank of Canada had started talking in more detail about the perils of debt. To keep up with those surging house prices, Canadians had mortgaged their futures like never before, prompting the central bank to worry about financial stability.
There was another particularly bad omen. Home Capital, a smallish mortgage lender, had cast a dark shadow over the real estate market. A couple of years earlier, the firm realized that a few dozen brokers it worked with had been filing false mortgage applications. Home Capital insisted the issue was minor, but its executives couldn’t make the problem go away. If you saw The Big Short, you know that rampant fraud was at the heart of the U.S. housing collapse in 2006 and 2007, and alarm bells were sounding.
All the talk was of bubbles and crashes. Vancouver prices cratered after the provincial government began taxing international buyers. Real estate in the Greater Toronto Area was still on fire, but that no longer felt like a good thing. Prices in the GTA jumped almost 30 per cent in February. (February!) Panic set in, and the new class of paper millionaires rushed to cash in while they still could. In May, new listings in Toronto increased 40 per cent from a year earlier, then jumped 60 per cent in June.
“The housing market is on the verge of a potentially severe downturn,” David Madani, an economist at a research outfit called Capital Economics, advised his clients around this time.
Madani, who has a knack for getting his name in the papers, had been predicting doom for years. But in early 2017, it felt like he might finally be proven right. And then Warren Buffett showed up.
Let’s get something out of the way: this may be another story about Canada’s housing mania, but this isn’t a story about bubbles and crashes. Bad things could happen; of course they could. It would probably take a recession to do the damage, and Canada’s economy hasn’t looked this good in years. Yes, higher interest rates could cause indebted households some pain. The Bank of Canada knows that, which is why it has been clear in saying that it intends to raise interest rates slowly. It doesn’t want to trigger a wave of personal bankruptcies.
From here, the most likely scenario for Canadian real estate is that prices level off. Various governments have introduced measures to cool demand, but the politicians have been tentative, leaving most of their voters’ cherished housing subsidies intact. So don’t get too hung up on all the talk that government policy has killed demand. The political class has a vested interest in keeping home prices buoyant: real estate has become a big part of the economy and, as such, an important source of revenue. You might even say that real estate is too big to fail, a political reality that will disappoint the economics academy but reassure a nation in which nearly 70 per cent of the population now owns a home.
Bottom line: don’t believe everything you read about Canada’s housing market. The best of times are over, but the worst of times remains a low-probability event.
Now let’s get back to Buffett, the world’s third-richest person and a bringer of financial stability. In June, Buffett, who works through his holding company, Berkshire Hathaway, received an email from a contact in Canada about an investment opportunity: benighted Home Capital, which by this time was being portrayed as Canada’s version of Lehman Brothers, the investment bank whose bankruptcy is synonymous with the Great Recession.
Marc CohoDes, an infamous short seller who bets against companies from his chicken farm in California, was trashing Home Capital on Twitter and in the media. The Ontario Securities Commission had accused the firm of misleading shareholders over the fake mortgage applications. Depositors were fleeing, and the stock price had plunged 70 per cent. In May, The Globe and Mail reported that regulators were hours away from forcing Home Capital to shut down.
All this had made the overall housing gloom worse. Goldman Sachs, the influential New York–based investment bank, doesn’t pay a lot of attention to Canada, but that didn’t stop if from putting the odds of a True North financial crisis at 30 per cent. The value of the Canadian dollar dropped, and investors sold their shares in Canada’s six biggest banks, even though each one had just posted massive quarterly profits. Buffett absorbed all of this information from his station in Omaha, Nebraska. But instead of an imminent collapse, he saw opportunity. “I’m bullish on Canada,” Buffett would tell The Globe a few weeks later.
The comparisons between Home Capital and Lehman were nonsense; one was a tiny purveyor of home loans that represented about one per cent of the Canadian market, the other was a legendary Wall Street firm that had dealings with virtually every major bank in the world. If Home Capital went down, Bay Street wasn’t going down with it.
Buffett saw through the sensationalism. He preys on panic: when mortals lose their heads, he comes down from the heavens and buys at a discount. Buffett would have known that even if Home Capital did run out of money, the Office of the Superintendent of Financial Institutions in Ottawa would take over the firm and distribute its assets. After 10 days of assessing the situation, Berkshire announced that it would purchase $400 million worth of Home Capital stock and extend the firm a $2-billion line of credit.
“Essentially,” said Buffett, “I feel Berkshire’s participation is very likely to improve an already reasonably stabilized position.”
You don’t have to be a billionaire to take advantage of fear. Quentin D’Souza has been honing his investing strategy for 15 years. He started out trading stocks, bonds, and mutual funds. But when he learned that his wealth manager was driving a Jaguar — while he was driving a Pontiac Sunfire — he figured there must be a better way.
The guy driving the Jag had always steered D’Souza away from property. D’Souza, who is based in Whitby, Ontario, decided to go his own way. Since the 1970s, home prices in the Toronto region have trended consistently higher. Also, demand was growing faster than supply. D’Souza decided to become a landlord, buying properties, fixing them up, then renting them out. “People always need a place to live,” D’Souza says. “But they can stop eating at McDonald’s. They can stop shopping at Walmart.” His point: a stock investor has little control over his or her investments. As a property owner, he says, “I have direct control over the asset.” D’Souza now owns a couple of dozen buildings through his company, Appleridge Homes, and has written three books about the rental business. Recently, he bought himself a new truck.
“People are scared. When people are scared, it’s an opportunity.”
For some, D’Souza is an emblem of Canada’s problem: another blind fool who believes house prices will never fall. But he isn’t a pure evangelist. For example, he’s wary of the Toronto condo market and says thousands of already stretched buyers could be in for a shock if they ever have to pitch in on a major repair of the glass tower for which they are now partially liable. His spreadsheets of historical prices in the Greater Toronto Area show that booms sometimes lead to busts: it happened in the 1970s and again in the 1980s.
The latest data has convinced some that a third collapse is inevitable. Home sales dropped more than 30 per cent in August from July, and new listings were the lowest since the summer of 2010, according to the Toronto Real Estate Board. Prices are holding up, though. The average cost of a home in the GTA in August — $732,292 — was still three per cent higher than it was a year earlier.
That fits with D’Souza’s outlook. The era of double-digit price increases is over, he says. But if you are willing to buy and hold, he doesn’t see how anyone can lose money on Toronto housing. D’Souza has been taking advantage of the softer prices, adding a few more properties to his collection over the summer. He says he will be looking out for more.
“People are scared,” he says. “When people are scared, it’s an opportunity.”
There is still a lot of smart money that sees potential in housing. That will keep upward pressure on prices; maybe not enough to drive big returns but likely enough to forestall a financial crisis.
And if it doesn’t? Canada’s banks are flush with cash and it would take a lot to topple them. Chris Catliff, chief executive of Blueshore Financial, a credit union in Vancouver, said housing prices could plunge 30 per cent and his firm would still be fine.
There’s another backstop: you, the taxpayer.
David Dodge, the former Bank of Canada governor, told me earlier this year that no government would let the real estate market collapse. Later, I heard Finance Minister Bill Morneau describe for an audience in Montreal what voters expected of him. Among other things, “they are counting on you to ensure their home keeps its value,” he said. That’s not the kind of thing you say if you are indifferent to the housing market.
Ottawa has grown wary of supercharged price increases, which is why Morneau made it more difficult to qualify for a mortgage. But that’s aimed at discouraging people from taking on loans they can’t afford. No one in Ottawa is talking about orchestrating a correction.
Some wish he would — Vancouver and Toronto rank among the most unaffordable cities in the world, and things aren’t much better in Montreal, Calgary, and Edmonton, according to Demographia, a St. Louis–based consultancy that studies urban planning.
Prices rose dramatically faster than incomes over the past decade, and home ownership in too many places is now the preserve of the wealthy. It’s a problem that governments will feel pressure to address.
That doesn’t mean prices will fall. Ottawa and local authorities in British Columbia and Ontario have been tentative in their attacks on runaway property markets. Here’s why: economists reckon housing and associated industries, such as construction, now account for at least 20 per cent of Canada’s gross domestic product. An economic engine of that size must be adjusted carefully. Royal Bank of Canada estimates that a 10 per cent drop in national house prices would erase a full percentage point from GDP growth. That would kill what has become an important revenue stream for governments across the country. Ontario projects it will earn $3 billion from land-transfer taxes this year, the difference between a budget surplus and a budget deficit heading into an election year. In 2016, British Columbia’s government earned $2.2 billion from various real estate taxes, more than it nets from forestry and mining.
These are the numbers you don’t hear about in most real estate conversations. And they’re powerful incentives to keep prices aloft.
In September, the Bank of Canada raised interest rates for the second time in two months — a startling development, given that it hadn’t turned the dial in the direction of higher borrowing costs for seven years.
One of the reasons for the change was to curb our credit lust: the central bank sees all that debt as a vulnerability. The second increase was prompted by data that showed the Canadian economy was growing at an annual rate of 4.5 per cent — much faster than central bankers think is possible without causing inflation. That put the benchmark rate at one per cent — still very low. And it might stay there for a while. The central bank said future increases would depend on a handful of factors, including the “sensitivity of the economy to higher interest rates.” That’s code for: we intend to go slow.
A last bit of perspective. A year ago, the Vancouver market looked wobbly. Buyers were thrown by that tax on foreigners, and the market retreated. Now it’s coming back. The average price for a home in the Greater Vancouver Area was $1.03 million in August, a 9.4 per cent increase from a year earlier, according to the Real Estate Board of Greater Vancouver.
It should surprise no one if something similar occurs in Toronto. Yes, prices are high, maybe even too high. But the conviction that real estate is the ultimate investment runs strong with Canadians, so much so that D’Souza, who would benefit personally if more of us would rent, can’t stop preaching the benefits of ownership. “I even encourage the people who rent from me to buy,” he says. Warren Buffett would be proud.