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October 24, 2012

 

Title: Housing storm clouds in sight

Subtitle:  Revised consumer debt data and lower existing home sales signal weakness ahead.

 

Warren Buffet once noted that: “You only find out who is swimming naked when the tide goes out," an expression which appears to have increasing relevance in Canada’s housing market.

 

Walk in almost any residential neighbourhood these days, ranging from Toronto’s condo factories to Vancouver’s outrageously-priced suburbs and you’ll see beautiful homes, on perfectly maintained lots, with late model cars nearby and flat-screen televisions peeking through brand-new windows. And the question inevitably comes up: how do they afford it all?

 

Lately, it’s becoming increasingly clear that that debt is playing a bigger role in consumer spending than we once thought.

 

Although Canada’s tight banking system prevents most homeowners from swimming naked, recent Statistics Canada revisions indicate that the average household debt to disposable income ratio was 161.8 percent in the first quarter of this year, up from a previously-reported 152 percent, which was already a record. Worse, that high total increased to 163.4 percent in the second quarter, although average household wealth was also revised upwards.

 

According to one expert, the updated data are even worse than they appear. “The revisions result in both a higher level of indebtedness and a faster rate of increase over the past decade,” notes Peter Buchanan, of CIBC World Markets, adding that Canadian consumers are still in better shape than those in some other countries. “The new estimates are likely if anything to add to the already-intense focus on debt levels and the potential limitations they place on (consumers’) ability to support growth going forward.”

 

Tough economic times

The challenges posed by the worsening consumer debt levels reverberate far beyond the housing sector, affecting potential spending throughout the economy.  Worse, businesses, aware of the bleak environment don’t look like they will be spending much either, judging from a recent Bank of Canada survey of business investment intentions.

 

The Business Development Bank of Canada, also recently released the results of research which slowed that only 56 percent of small business owners plan to invest in their activities during the coming year. That’s important because small business has been the primary creator of new jobs in recent decades, with taxes created from those jobs, financing further government employment or public sector job retention. During a recent presentation at the Board of Trade of Metropolitan Montreal, Pierre Cléroux, the BDC’s chief economist called the results “encouraging,” but added that he would like to see those good intentions translated in action.

 

The good news, is that despite a drop in existing home sales, Canada’s housing market still seems to be holding out. According to the Canadian Real Estate Association, transactions made via its Multiple Listing Service fell by 15.1 percent in September, compared to the same month last year, however prices actually rose by 1.1 percent. Furthermore Statistics Canada reports that new home prices increased during August by 0.2 percent, following a 0.1 percent increase in July. The continued demand encouraged homebuilders to begin construction on an impressive 220,215 units in September, down slightly from the previous month, but nevertheless an extremely bullish number in historical terms.

 

Check those trunks

That said, although residential real estate prices continue to rise, the fall in transactions is worrying, as these kinds of drops often precede price decreases. In short, the new data provide Canadians to take a new look at their finances to make sure that they are on solid ground, as “surprising” reappraisals of financial conditions (such as the debt revisions noted above, tend to be part of worsening economic times, as previously rosy assumptions are questioned.

 

Recent reports that Canada Mortgage and Housing Corporation’s house appraisal tool, known as Emili, may have been overvaluing properties (and thus fostering approval of larger mortgages than would otherwise have been the case) provide similar cause for concern.

 

In short, the next time they go swimming, the more astute Canadian homeowners will be drawing lessons from those warning signs, poking around below the water level to make sure that they have bathing suits on.

 

peter@peterdiekmeyer.com

 

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