The Canadian Housing Market

In an Econometrics course I took in grad school, I had a professor tell us that the stock market crash in 1929 was not the result of an asset bubble, because, if you had certain expectations of returns and interest rates, then the market was actually within reason. I was flabbergasted, if the stock market was not in a bubble, then is a bubble even possible?

Well, if you read the mainstream media about the Canadian housing market, you will come to the same conclusion, there is no asset bubble. If you assume that interest rates will stay at near zero, and that housing prices will still provide a decent return, then prices are within reason.

Let's see an example. If the average family who buys a house in Canada has combined income of 100K, and they can afford to put 2100 to a mortgage, and given that the average down-payment is now 5%, interest rates are 2.5%, amortization rate is 35 years, then this couple can afford about a 600k house.

Of course, this is assuming that 2.5% is sustainable, which it isn't. If this increases to a more reasonable 5.5%, then this couple can only afford a 400K house. And if interest rates increase to 8%, they can only afford 300,000.

I'm often surprised how few people understand this simple math, how many people tell me that this is a great time to buy. I would argue that this is the worst time to buy, and not only because interest rates will go up. Although the monthly payments are the same in both situations, one had a principle of 600K and one has one at 300K. Beside the lower property taxes, you are much more likely to pay off 300K within a reasonable time than you are 600K.

And of course, real Canadian incomes are not going up, nor will they, for reasons we will cover later. So the amount a family can put towards a monthly payment will not increase. SO they only variables that matter are the interest rate, and the amortization rate. And an amortization rate of 35 means that many families will approach retirement before they will pay off their house, so I don't see this going up, and will likely go down when interest rates go up.


We'll go over the causes of this crazy housing market later on, but for now, I hope you can agree with me that this is not a good time to buy, in fact, it may be the worst time. Think about this math the next time you read about line-ups at Condo openings, or with multiple bidders driving prices up 50%. Why were there no line-ups 10 years ago when prices were half of what they are now?