“Could You Survive A 40% Plunge In House Values”

The headline alone has to grip you, doesn’t it?

This article first appeared in Thursday’s Globe & Mail, and I’m still trying to wrap my head around it…

“Could You Survive A 40% Plunge In House Values?”
By: Michael Babad
The Globe & Mail

DBRS Ltd. is highlighting a somewhat shocking number today. The ratings agency isn’t saying it’s going to happen – not for a moment – but it does say Canada could withstand a plunge in house prices of 40 per cent.

That’s a dangerous number, but the DBRS study says it wouldn’t put most Canadians under.

“A catastrophic 40-per-cent property value drop would reduce household net worth by $93,000 and lower the average equity ratio to 44.8 per cent from the current 66.9 per cent, but would be unlikely to cause immediate, large universal mortgage defaults,” says the study, whose lead author is Kevin Chiang, a senior vice-president.

There is no timeline for that.

That doesn’t mean DBRS isn’t concerned about the mounting debt burden among Canadian families, and what it sees as “stretched” housing affordability. Other observers have also sounded warnings.

Household debt, it finds, ballooned by more than 381 per cent between 1990 and 2011, to $1.6-trillion, while average home prices reached almost five times average gross income.

“While housing prices increased faster than the average household income, the current affordability ratio of 37 per cent is aided by the low interest rate environment and is only slightly worse than the long-term average,” the report says, though it notes that an increase of 2 per cent in mortgage rates could drive that to 43 per cent, or more, of pre-tax income.

“An increase in mortgage rates or a home price correction in itself, in DBRS’s opinion, does not have a large impact on mortgage defaults,” according to the study.

“However, a combination of higher interest rates, lower property values and a drastic increase in unemployment would be of great concern as mortgage defaults are closely related to employment and individual family situations. Higher interest rates would likely cause some households to reduce consumption and fewer people would qualify for the same mortgage amount, putting downward pressure on housing prices.”


If you simply read the headline, scrolled down to the bottom, and are reading this now – the answer to the question is “yes.”

YES, according to the article, “Canada could withstand a plunge in house prices in house prices of 40%.”

So let me go out on a limb here and say something that isn’t just to stimulate conversation, but rather something I truly believe: the real estate market will not drop 40% in Canada.

I won’t insult your intelligence and say something like, “This baby is shooting for the moon!  The market is going to increase forever!”  No, I’ll leave that for the pure salesmen in my line of work.  The market will level off at some point, no doubt.  When is the million-dollar question, since those people saying “Stay tuned – the great crash is happening” have been saying that for nine years, during which time, Toronto house prices have almost doubled, and those geniuses have left huge tax-free capital gains on the table…

I won’t make a prediction on when or by how much the market will decrease, but I will say that it won’t drop 40%.  It can’t.

So often, people say things like “Anything can happen to our economy!  Look what’s going on in Greece!”  But we aren’t Greece; not even close.  We’re not socialists; we’re hard-working Canadians who understand the value of a dollar and who, with the exception of Quebec it seems, are willing to acknowledge that success and financial gain in this world simply cannot be achieved without hard work.

I just don’t see Canadians up-and-leaving the work ethic and values that have brought us this far.

Our economy is healthy, both on its own, and grading on a curve when you consider what is going on around the world.

There is no doubt that the real estate market cannot continue its upward trend forever, but I don’t see a 40% drop across the table in Canada, and let’s remember that Toronto would likely not depreciate anywhere close to the national average, if that were the case.

Am I being a dreamer?

Is my cup beyond half-full?

I don’t think so.  I read this article and thought, “Oooookay.  Well, it’s nice to know that the experts think our country could withstand a monumental drop in real estate values.  That says something about the health of our economy.”  But I followed that up with, “It’s also nice to know that we’re not dropping 40%….”

Every day, I open the paper and read about two things that bother me to no end: Greece & Quebec.

These two regions are faced with a host of different problems, but these problems can all be traced back to the source: entitlement.

Quebec students are lazy, ignorant, and entitled.

Is Greece any different?

Don’t all these people want something for nothing?

I’ll spare you my rhetoric.  Every time I sound off on politics, one or two readers, who disagree with my political views, will comment, “You should stick to writing about real estate.”  Nobody who actually agrees with my political views has ever advised me to act accordingly…

But as Canadians continue to work hard and produce, I keep thinking that this country is on its way to being a worldwide super-power.  Real estate values will correct at some point, but I don’t see a crash coming, and I think, as the article above suggests, that we can withstand short-term fluctuations on our way to long-term triumph.

32 Comments

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  1. Cédric Lajoie says:

    I don’t think that the rates of the market are going to drop by that percentage as it is just an assumption.

  2. Jason says:

    I don’t believe housing prices will drop 40% but experts said the same things about the US market when the sub prime market started to topple. If you just look at 40% drop and assume little else changes then yes we could weather a drop and just keep making the mortgage payments.

    But severe housing prices don’t drop in a vacuum, I have a decent amount of equity in my home. But if prices dropped that much, it’s the other drops in economic activity that would sink my business causing me to default.

    The financial system is so complicated right now, I’m not sure the human brain can really, truly understand it. Regardless of how smart you are or how long you think about it, so how can anyone make predictions like this?

    Though personally I agree with you, prices will probably stagnate once interest rates rise, and I would imagine policy makers will drag those increases out over years in small increments so with a little luck most of our incomes will keep pace with the increased costs.

  3. Hello Goodbye says:

    Entitlement… what comes to mind in Canada is the fact that 70% of Canadian households own a home. Canadians feel ‘entitled’ to the home ownership ‘dream’, and CMHC and the banks make it easy to achieve.

    Yes – it’s crazy that Quebec students are literally fighting against tuition fees that would still be ridiculously low compared to almost anywhere in the world, but that is not the only ‘entitlement’ problem in this country.

    A 40% fall is possible in certain markets — most likely the ones that have gained the most (and the fastest). Prices tend to overshoot in each direction, so if we’re say 15%-20% over-valued (an arbitrary number, but similar stats have been noted by many economists), falling 25%-30% or more is a likely outcome.

  4. Potato says:

    “There is no doubt that the real estate market cannot continue its upward trend forever, but I don’t see a 40% drop across the table in Canada, and let’s remember that Toronto would likely not depreciate anywhere close to the national average, if that were the case.”

    Are you suggesting Toronto would fall less than the national average? Most predictions of a decline have Vancouver and Toronto leading the way down, not resisting the trend.

    “those people saying “Stay tuned – the great crash is happening” have been saying that for nine years”

    Nine years? Who said that nine years ago? I thought I was rather early to the bear party, and that was “only” four years ago.

  5. Cid says:

    Sorry David, you don’t understand the Greeks. They are perfect economic actors who responded to incentives as rational self-maximizers. It’s just that more experienced states introduce laws and regulations and effective enforcement to ensure that the aggregate result of classic economic behaviour does not destroy the economy and society. What’s been happening in the Toronto real estate market these last few years looks pretty Greek to me.

    BTW, I am a Canadian of Greek origin who works hard and pays his taxes with Calvinist zeal.

  6. entitlement generation says:

    I don’t like my Toronto property taxes.
    So I’m going to go throw a brick through a mom/pop store’s window.

    I don’t want to pay $75 to renew my Ontario plates.
    So I’m going to throw a moltov cocktail at the police, and start a bonfire that stops traffic.

    I’m going to riot, in a face mask, violently, for 100 days, so other taxpayers can’t get to work.

    If get trampled, I fully expect to be driven (in a taxpayer-funded ambulance) to the (taxpayer-funded) hospital.

    Then I’m going to invite the Greeks to join us here in la-la land.

    Sorely misplaced sense of entitlement, anyone???

    1. Masud says:

      This is a perfect perspective!

      I LOVE IT!!

      They all want something for nothing. They need to take an introductory economics course and learn that you can’t just expect your government to print money over and over without consequences.

      Today’s youth wants everything, and is willing to nothing for it.

  7. Moonbeam! says:

    Hey Dave — I’ll go out on a limb and say that I like Stephen Harper, we live in the best country in the world, I count my blessings, and so should all Canadians citizens and landed immigrants… A pox on the Quebec student protesters, the occupy movement, and the rest of losers in Canada…

    1. Solange says:

      Totally agree with you David and Moonbeam!

    2. Ralph Cramdown says:

      So how many countries have you lived in, for at least a few years? I think Canada is great, but I don’t think I have the experience to say ‘best’. In fact, I doubt it. Of the world’s 6BN citizens, many of whom fervently believe that they believe that they live in the best country on earth, how many are likely to be right? It’s like religion — sure, yours is the One True religion, but isn’t that just because it was your father’s religion, too?

  8. Jeremy says:

    David,

    I’d like to comment on the following excerpt:

    “since those people saying “Stay tuned – the great crash is happening” have been saying that for nine years, during which time, Toronto house prices have almost doubled, and those geniuses have left huge tax-free capital gains on the table… ”

    I for one think that there will be a crash- and I encounter this argument frequently: that people have been saying there will be a crash in Toronto for the past 9 years and it hasn’t happened yet, and a broken watch is right twice a day, yada yada yada… and you could have made X amount of money.

    The fact is- my opinion is based on a snapshot of this point in time- focused on a myriad of factors- (including the huge gains of the past 9 years) The fact that people have said that in the past and it hasn’t happened yet is irrelevant.

    To illustrate my point, if someone said that Apple corp. is overvalued and due for a correction- you wouldn’t counter that argument with “analysts have been saying that Apple’s stock has been overvalued for the past 9 years, but during that time, Apple stock is up 10,000%, and those geniuses who didn’t buy have left huge tax(able) gains on the table….”

    my 2 cents.

    1. Devore says:

      Dismissing someone’s position that real estate will decline 40% with “well, people have been saying that for 10 years” is the lazy way out. Pick ANY position, ANY opinion, and you will find someone who has been saying it for 10 years. And because someone has been wrong for 10 years and “missed out”, has zero bearing on the reality today. Their opinion is irrelevant.

      Like you said, you have to look at the here and now. To say something won’t happen because you don’t believe in it, or because it “just can’t happen”, again, lazy thinking. There are plenty of precedents where real estate (even in Toronto) declined 40%. Certainly market segments have. And if you look at real, inflation-adjusted dollars, nearly every real estate bull market corrected 40%. Is it different today?

      As for people surviving 40% drop… vast majority will, because they will still be able to make mortgage payments tomorrow that they are making today. However, an economy driven 65% by consumer spending (hello HELOC!) and 20+% driven by housing and the shoot-offs in the FIRE sector, a 40%, or even 20% drop would have massive consequences. Equity would evaporate, and so would HELOCs. Trades, builders, construction workers, realtors, mortgage brokers, etc, would see their incomes squeezed. This too will impact consumer spending, and jobs outside the FIRE sector.

      In isolation, a 40% drop is nothing. But even a modest and prolonged decline would have very serious consequences in a chain reaction. Too much of the economy is driven by housing, too much housing is driven by easy lending, and too much consumer spending is driven by equity gains.

      1. Vlad says:

        @Devore
        Excellent comment.

        As you put it, it would take much less than 40% to take down the whole house of cards.

  9. David P says:

    It’s interesting that everybody is equating the Quebec protesters with Quebec students, when the majority of students aren’t even siding with the protesters.

    “Lazy, ignorant, and entitled” might be a bit harsh. I think it’s more like “fighting for the same benefits their entitled predecessors had so that they can be even more entitled since tuition hasn’t even been adjusted for inflation”.

  10. Matt says:

    Entitlement also includes 20 and 30 somethings who want granite countertops and all the best upgrades.

    Recent real estate prices have grown in tandem with household debt. Household debt levels are reaching the stratosphere. So if you believe that household debt levels can just keep going up, all the way to the moon for 2, 3, 5 more years, then keep believing that real estate prices will do the same. I for one would rather believe that the laws of economics will prevail. Oh ya, and just wait until interest rates start going up; an issue that will only compound a lifetime of astronomical household debt.

    Do I believe 40% decline? No. But I also don’t believe debt levels can keep growing and thus, real estate prices will hit a similar wall, as both figures move in tandem.

  11. Ralph Cramdown says:

    Just as an aside about Quebec: Do you believe in free universal primary and secondary schooling? If so, why should university be different? If Canada’s going to be a superpower, we need a skilled, educated workforce, and they’ll pay more taxes and produce more GDP, too.

    If you’d bought an “average” Toronto home for $261k in 1989 and sold it for $189k in 1993, you’d have lost 27% in nominal dollars. 189 1993 dollars was equivalent to 163 1989 dollars, so you’d have lost 38%, plus expenses, in real terms. Were Canadians different back then?

    1. Pen says:

      Aside from the housing market crash, fundamentally who really cares what the equivalent cost of 1993’s dollar was in 1989? Did anyone walk into a bank in 1993 with a ‘nominal’ dollar and say I’m depositing its 1989 ‘nominal’ value?

      What point are you trying to make?

    2. jeff316 says:

      Were Canadians different back then? You bet they were. Was Canada different back then? You bet it was. Is it different this time? Of course it is.

      The question is *how different*, why, and how those differences will affect the response of consumers, policy makers and the market.

  12. Joe Q. says:

    David,

    If I’m not mistaken, the Toronto average re-sale condo price dropped by 40% over a period of about four years in the early 1990s. (You can check the TREB archives and confirm) So while I make no predictions about how big a “correction” or “crash” we will experience, there is indeed precedent for a 40% drop, at least in some categories.

  13. Paul says:

    David, I would like to know why you have such a negative opinion of Quebec students, those are harsh words to make without giving a little detail to your frame of thought.

    The simple fact that such a large number of students have managed to organize, in a democratic fashion no less, such activities and protests shows they are not simply lazy and “complaining with their mouths full” they understand the ramifications of rapid tuition increase and the burden this is to cause not only them and their parents, but to future generations as well.

    1. @ Paul

      I suppose the “Occupy Toronto” protest was meaningful as well?

      If by “democratic fashion” you mean wearing black masks and storming into classrooms so that the very few students who DO want to get an education, can’t do so, and are scared and threatened, then yes – it’s democratic. If by “democratic fashion” you mean throwing molotov cocktails, burning things in the street – oh yeah, totally democratic.

      My “frame of thought” is echoed by every Canadian, outside of Quebec, and outside of you, respectfully. Put a number to it – what percentage of Canadians outside of Quebec are sympathizing with their ’cause’? Less than 1%? Likely.

      The 100,000 person march the other day – that is democratic. But that came after weeks of guerilla tactics that scar this otherwise proud nation.

      This ‘movement’ is having less and less to do with students’ tuition, and is gaining more and more Quebec separtists, anti-governmental protesters, and all around haters.

      1. Davud says:

        “If by “democratic fashion” you mean wearing black masks and storming into classrooms so that the very few students who DO want to get an education, can’t do so, and are scared and threatened, then yes – it’s democratic. If by “democratic fashion” you mean throwing molotov cocktails, burning things in the street – oh yeah, totally democratic.”

        So it’s democratic for Harper’s majority to enforce it’s will on Canada with just over a third of the vote, but a movement that sees students vote with an overwhelming majority weekly to continue the strike is anti-democratic?

        “My “frame of thought” is echoed by every Canadian, outside of Quebec, and outside of you, respectfully. Put a number to it – what percentage of Canadians outside of Quebec are sympathizing with their ’cause’? Less than 1%? Likely.”

        You’re drastically underestimating the support and potential support that both these students and the Occupy movement have. It’s dangerous to be so absorbed in your own worldview. (How many Canadians do you think support the EI changes, or the Old Age Security Changes, etc..)

        “The 100,000 person march the other day – that is democratic. But that came after weeks of guerilla tactics that scar this otherwise proud nation.”

        Tuesdays protest was estimated at well above 100,000, some mainstream media sources reported figures of double or triple that (The National Posts estimate was above 100,000). This is the 3rd time in 3 months that more than 100,000 people have taken to the streets of Montreal. YOU just didn’t hear about it the first 2 times ( I guess it takes 3 tries before media doesn’t ignore it).

        http://www.theglobeandmail.com/news/politics/just-watch-us-100-days-in-protesters-declare-their-right-to-march/article2440566/

        “This ‘movement’ is having less and less to do with students’ tuition, and is gaining more and more Quebec separtists, anti-governmental protesters, and all around haters.”

        You’re right. It’s not just about student tuition: http://www.huffingtonpost.ca/larry-rousseau/quebec-protest_b_1541432.html (for a start….)

        1. Anony says:

          What a joke. Quebec students pay the lowest tuition in North America. It’s like a homeless persson getting a free prime rib steak and then saying “What? I asked for medium-rare and this is medium!” The word entitled does not begin to explain the situation.

        2. Anony says:

          PS If we’re opening the door here to talk about EI changes, are you saying you agree? Should a landscaper who works six months per year be able to go on EI in the winter, then back to work in the summer, then back to EI in the winter, on and on, forever? This is called “selectively working.” See: Greece.

          1. Duvid says:

            Hey “Anony”

            Premises about homeless people aside. Explain your analogy. Are all students beggars or just Quebec students? Should an institution such as education which is supposed to be so fundamental to social mobility not be accessible? Does it not make sense that the society with the most robust history of fighting for accessible education in North America has the most accessible education in North America? Should that society suddenly stop fighting for those values because they’ve been successful?

            Re: EI
            Should someone with 20 years of experience who had been earning 80000$ give up searching for equivalent employment and settle for a junior position at $56000? Even if you do my point was that many Canadians understand that issue better than you.

        3. entitlement generation says:

          Davud, why is it that the poor dears in Quebec who complain about a MINIMAL tuition increase of $325/year do not hesitate to dole out $5/day for lattes (365 days in a year, Davud, adds up)? Why do they not think twice about paying hundreds for their IPads and Blackberries, while dressed in the latest from Abercrombie and Hilfiger as they “protest” in the (taxpayer-funded) streets? Oh, and don’t forget the cost of purchasing professional face masks (how proud their parents must be; nothing like cowering under facial cover while violently looting and rioting lawlessly for your “cause”), and the equipment used to make all those smoke bombs they threw into the Metro. The only good news is that only 40 McGill students (out of 40, 000 on campus) have taken part in this lawlessness.

      2. Floom says:

        Well said.

      3. Paul says:

        The protests are about much more than a simple tuition increase, they’re about a shift in ideology, we cannot treat education as a commodity. The only reason quebec students currently pay lower fees is because they have spoken up against them repeatedly throughout the years. If students in ontario should be the one complaining, then COMPLAIN. complacency will bring us nowhere.

        Here’s a reason why, in the US, their current generation is less educated than that of their parents: they cannot afford to go to school. A debt-riddled generation contributes poorly to the development of their society.

        Comparing Quebecs tuition fees to Ontario is a lazy argument, while Quebec does have the lowest tuition fees, students in Quebec pay three times the amount in taxes, that’s right three times!!!!

        Quebec’s Income Tax Rate:
        16% on the first $40,100
        20% on the next $40,100
        24% over $80,200

        Ontario’s Income Tax Rate:
        5.05% on the first $39,020 of taxable income, +
        9.15% on the next $39,023, +
        11.16% on the amount over $78,043

        I happened to be in Montreal last weekend and witnessed some of the protests, while I’ll agree there were a few “protesters” who crossed the line, the majority of the people did not support their acts. There are always some bad apples.

        But to make such harsh comments about an entire populace without truly trying to understand the other side is ignorant.

        1. johnny chase says:

          Quebec gets subsidized day care at $7/ day. I’ll take their taxes and the day care subsidy anyday,

    2. Joe Q. says:

      I’m all for keeping tuition fees low — as long as we also set university entrance standards higher than they are currently. There is a lot to admire in the German system (university tuition is practically free, but students have to pass rigorous entrance exams to get in; they also have a highly stratified system with excellent technical and trade colleges).

  14. Anonymous says:

    Quebec is Canada’s Greece.

    1. RAFFI says:

      If not for the obvious geographic issues, I wouldn’t mind at all if Quebec separated and found out what life would be like living on an island of self-entitlement. The true hard-core francophones don’t respect the rest of Canada in the slightest, and theyre socialist mentality is going to sink them/us. I’d prefer not to go down with the ship the way Greece is about to.

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