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Until Moody’s downgraded the credit ratings of six major Canadian banks due to the rapid expansion of private sector debt and the real estate bubble, and then on Wednesday, the International Monetary Fund (IMF) warned that uncertainty from real estate has become one of the two major factors threatening Canada’s macro-economy.
Since 2015, in response to the damage caused by falling oil prices, the Bank of Canada has cut its benchmark interest rate to 0.5% in the hope of stimulating economic growth. Until the recent rate negotiation on May 24th, the Bank of Canada kept its benchmark interest rate at a low level of 0.5% for a year and a half. Because of the low interest rate as the main inducement, coupled with the entry of internal and external speculative capital, Canada’s real estate industry has expanded rapidly since mid-2015. Canada’s MLS composite house price index rose by a considerable 19.8 per cent in April compared with the same period last year, according to MLS. In mid-2015, the index was at a mere 5%.
With regard to the health of the real estate industry, there have been three widely recognized indicators-the price-to-income ratio, the housing affordability index and the rent-to-sale ratio. According to these three indicators to “follow the clues to find” to consider whether the Canadian real estate industry is reasonable or not is the most straightforward way.
First of all, the price-to-income ratio (Prices Against Income Ratio). The so-called price-to-income ratio refers to the price of the next house is how many times the income of a family. According to the international consensus, the price-to-income ratio in the range of 4-6 times is relatively reasonable. The price-to-income ratio in Canada remained fairly stable at six times from 2010 to 2015, but has risen sharply since 2015, according to data released by Moody’s Analytics on May 2. Up to now, the price-to-income ratio in Canada has been quite close to 7 times.
Second, housing affordability index (Housing Affordability Index). The so-called housing affordability index takes the median income families in a certain region as the sample families and their ability to pay for the median price housing in the market in the same period as the representation of the overall housing affordability of the residents in the region. Compared with the ratio of house price to income, the housing affordability index takes the mortgage interest rate into consideration, so it is closer to the actual purchasing ability of the family. According to the latest data released by the Bank of Canada, as of the fourth quarter of 2016, Canada’s housing affordability index was 0.337, up from 0.31 at the beginning of 2015. In other words, buying a house is becoming more and more difficult for Canadian residents.
As for the most frequently mentioned rent-to-sales ratio (Price to Rent Ratio), the rent-to-sales ratio of Canadian real estate was close to 1 190 by the end of 2016, according to the OECD. Although this figure does not fall out of the internationally recognized range of investable value, it still ranks among the countries with the highest rent-to-sale ratio in the OECD. The rent-to-sale ratio of 1RV 190 has actually indicated that the investment value of Canadian real estate is shrinking and the real estate bubble is gradually emerging.
From the above three sets of data indicators, it is not difficult to see that from 2015 to the present, Canadian real estate has indeed accumulated certain risks in a short period of time. In the face of high housing prices, both the purchasing power of residents and the value of the property itself are on the decline. These three sets of indicators are also used as a strong basis for bearish on the future of the Canadian real estate industry. At present, the most pessimistic bears even think that Canadian house prices will fall by nearly 40% in the near future.
In fact, in addition to the above three indicators, at the macro level, there are also some facts indicating the risks that may be faced by the Canadian real estate industry in the future.
The first is the rise in mortgage interest rates. Unlike the external environment when the 0.5 per cent benchmark interest rate was introduced in 2015, central banks around the world are actually on or about to raise interest rates. Among them, in addition to the pick-up in the economy and inflation, the pressure of the Fed to raise interest rates even because of Trump’s factor is also an important factor. Under such a general trend, the Bank of Canada is obviously not special, although the latest interest rates remain at 0.5%, but the move to raise interest rates is bound to not be too far away. In this case, there is a high probability that Canadian mortgage interest rates will rise, and the tightening of credit will obviously put direct pressure on Canadian house prices.
Second, the recovery of international oil prices is not as good as expected. The importance of oil prices to Canada is obvious. Although the pressure of the drop in international oil prices on Canada is not as great as that of the OPEC member countries, Canada has suffered a lot of losses in the fall in international oil prices. At present, although international oil prices have basically stabilized by US $50 per barrel due to production cuts in major oil-producing countries, it is difficult to determine whether the production cuts will continue after the previous six-month delay. Even after the postponement of production cuts announced the week before last week, oil prices still fluctuated around $50. At present, the market is generally not optimistic about the expectation of a future rise in oil prices. The continued downturn in oil prices is undoubtedly “bad news” for the income of Canadian residents. This transmission to the real estate, will directly affect the ability of residents to pay for the property market, thus bringing downside risks to the Canadian property market.
Another big negative factor for the Canadian real estate industry in the future is Trump’s announcement that he will stop the North American Free Trade Agreement (North American Free-Trade Agreement) with Canada and Mexico after taking office. This is undoubtedly true for the Canadian economy and residents’ income.