If you own real estate in Canada you may be feeling a bit of anxiety right now. As we head into 2018, there is a great deal of talk of a “soft-landing” and a “flat-lining” market — and this prompts concerns about an overall market correction and possible housing price declines.
At this point, the truly catastrophic folks are calculating how long they’ll have to work into their retirement years in order to make up the loss. But market corrections aren’t always a bad thing. Here are four things you need to know about this year’s real estate market correction.
Why do we need some perspective?
Market’s are cyclical. The stock market is cyclical, the option’s markets are cyclical, as are real estate markets.
Markets build-up, peak, then fall – when the process starts all over again.
For the better part of the last decade, we’ve been in the build-up phase of the cycle. Based on preliminary annual sales numbers it appears that most Canadian real estate markets hit their peak in 2017 and then started to fall. When a fall precipitates a 10% reduction — either in sales activity or pricing — it’s known as a correction.
Take, for example, the Greater Toronto Area market. While still considered one of the hottest property markets in Canada the GTA experienced a 7.1% drop in sales activity between 2016 and 2017. As a result, prices only ticked up, on average, by 0.7% year-over-year, while the average Days on Market (the number days a property sits on the market before selling) rose by 35%.
Historically, real estate market corrections are regular events that steadily occur over an 18-year rhythm, according to economist Homer Hoyt. This doesn’t mean that each market cycle lasts 18 years, but when Hoyt averaged out each market cycle, based on peaks in U.S. land values, the cycles lasted, on average, every 18 years. And this had been true since 1800.
So, where are we now? It depends on what market you look at. In the U.S., the 2008 Great Recession prompted a crash in the U.S. housing market. As a result, economists are predicting that the next American real estate won’t happen until 2024 when the cycle will start all over again.
In Canada, the last major price correction was between 1992 and 1996, when national housing prices appreciated by an anaemic 1%, compared to the 16% appreciation between 1988 and 1992 and the astronomical 70% price appreciation experienced between 1984 and 1988. Given this timeline, Canada is certainly overdue for a price correction (by about four years).
Keep in mind, however, that each market inside Canada will also move at its own pace. While Canada’s price correction is about four years overdue, Vancouver’s price correction is right on track. The last price correction was around the year 2000 when prices appreciated a meagre 3% (compared to 26% in the four years leading up to 2004, 59% in the four years leading up to 2008 and the 23% in the four years leading up to 2012).
It’s safe to say, then, that we are in the midst of a Canadian real estate market correction. And that’s normal and good.
But, why is a correction happening again?
Why? Corrections happen because investors become too optimistic about a certain asset and, in a frenzy, they keep buying that asset. This frothy activity pushes prices for the asset up and this creates more frenzy and optimism. This is when an investment’s price becomes disproportionately high compared to its actual worth. Some people realize this and get out. This can prompt a sell-off — when investors become highly sensitive and react to the potentially bad news by selling their stake. This causes prices to fall, or correct.
While real estate is more than an investment — it’s a lifestyle choice as well a personal financial decision — it’s still subject to market sentiment and this adds volatility to it as an asset class. In the last decade, there’s been a run-up in property prices. As a result, bankers, economists, analysts, columnists and financial planners are warning Canadians. This negative sentiment, combined with a lack of housing affordability and other economic realities, is prompting sensitivity among potential buyers. This combination of high asset valuations and spooked investors signals a cycle peak and eventually a market correction. The rhythm of real estate continues. A market correction is happening again. Relatively on schedule, if you believe Hoyt’s analysis.
The top dogs aren’t afraid, why should you be?
In late November 2017, Bank of Canada Governor Stephen Poloz released a report where he flagged the steady climb of household debt and the still-hot housing markets across the country as the financial system’s top vulnerabilities.
“Overall risks to the Canadian financial system remain elevated,” he wrote. However, it wasn’t all doom and gloom from the nation’s top banker. “Some preliminary signs of improvement, however, are emerging.” The report added: “Better economic conditions and several new policy measures support prospects for additional progress.”
In particular, Poloz and his BoC analysts were pleased by the initial impact of the stricter lending rules that were announced in late October (but didn’t come into effect until January 1, 2018). Despite elevated sales activity in the last two months of the year, the underlying trend in most Canadian markets was a slow down and a return to a more stable and balanced market.
For Poloz, the big concern was how susceptible these vulnerabilities were to an economic shock. Think about the economic fall-out when oil prices dropped in 2008 and, then again, in 2014. “Any shock that comes our way is going to be magnified by those vulnerabilities and that’s a concern for us,” said Poloz in November 2017. Still, Poloz believed that these “vulnerabilities” would be vastly reduced with the introduction of the new mortgage stress test and the forthcoming interest rate hikes.
Remember, for the first time in seven years, the BoC raised interest rates in 2017. While both rate increases were nominal — a quarter percentage point in July and another in September — it signalled a change in the central bank’s monetary policy. Now, the BoC is expected to continue gradually hiking rates going into 2018 and beyond.
Our economy is gradually picking up momentum
Would it surprise you to learn that a fifth of our economy relies on oil and other natural resources? According to Statistics Canada, the resource sector directly contributes 15% to Canada’s GDP (and provided 900,000 jobs in 2014). Add in the indirect impact and it’s another 5% to GDP and 900,000 jobs—as workers use their wages to buy homes, cars, go out for dinner, send money home and buy consumer goods. When oil prices dropped in 2014, Poloz estimated that $50 billion was taken out of the country’s national income. (For those interested, that works out to about $1,500 CDN per person.)
But in 2017, the Canadian economy gained a bit of momentum. The International Monetary Fund predicted that Canada would take the No. 1 spot for economic growth in 2017, among the G-7 nations and drop to No. 2 in 2018, behind the United States.
Economic growth and expansion is good news for all Canadians. It can help reduce debt, increase investments and, in turn, continue to help grow the nation’s economy and establish a higher standard of living for the majority of Canadians.
While it’s scary to see property sales fall, prices drop and real estate markets correct, it’s not a reason to panic. For those currently in the real estate market, there’s no reason to pull out in order to avoid a loss. For those trying to get into the market, think of the current market turmoil as an opportunity.
Remember, lots of stock market investors sold after the 2008 market crash—they sold at a low and weren’t invested when markets recovered the following year. Don’t make that mistake. Stick to your personal financial plan. Make property decision — and all financial decisions — based on this plan. The plan helps you define your goals, determine the steps to achieve these goals and identify any vulnerabilities along the way. And if you don’t have a plan, now’s the time to make one.