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Thursday, May 10, 2012

Is Household Debt the real estate market's Achilles Heel?

I have just returned from the studios in the CBC building in downtown Toronto where I was on CBC Radio discussing "My Quest for a Condo" and also Toronto's real estate bubble.

During the interview I asserted that household debt is the largest factor in Toronto's (and Canada's) real estate market.

So am I right? Is Household Debt the real estate market's Achilles Heel?

Yes, but its not the only factor.

The problem with having a radio interview is you can really only provide snippets of conversation within your allotted 6 minutes. There are many factors that go into the hows and whys the Toronto real estate market is going to have a US-style collapse within the next 3 years.

Exactly when I cannot predict, but I can pretty much guarantee it is going to happen when you consider ALL the factors.

#1. 60% of recent buys in Toronto's new condo market are from investors looking to flip the property for a profit. (Source: real estate research firm Urbanation) When Toronto's real estate market hits a serious bump they will sell the properties in a panic.

#2. Interest rates in Canada are currently super low, but if they go up too quickly it will hurt home and condo sales. If they don't go up or barely go up it will encourage an expansion of the current bubble by making credit too easily available.

#3. Foreign investors are taking advantage of Canada's banking and mortgage system wherein the banks put up the cash, the government takes the financial responsibility via the CMHC (Canada's version of Fannie Mae and Freddie Mac) as mortgage insurer and the foreign investors can cut and run if anything goes wrong. Real estate speculators are like sheep. They flee any market they can't make a profit in.

#4. Household debt in Canada is at an all time high. $1.61 TRILLION Canadian dollars.

#5. In 2012 banks started to refuse to give many Canadians more credit because they've recognized the threat of household debt (and financial losses from future bankruptcies). Too many bankruptcies will hurt bank profits so instead they're cutting back on credit availability.

#6. Less credit in Canada's current economic climate means a lowered consumer confidence level. People go out and spend less, tighten their belts and lack of spending = downward spiral into recession.

#7. Rising cost of living in Canada. Prices of food, gasoline and basic goods are all going up (partially due to high oil prices). Since food, gasoline and toilet paper are considered necessities it cuts into the household budget for other things (such as saving up for a house or condo).

#8. Toronto developers are currently building almost 3 times as many skyscrapers as New York City is currently building. Its a lot of skyscrapers. History has shown that developers start building skyscrapers en masse right before a major financial meltdown because land becomes too expensive but credit is too easily available so the only solution is to build vertically.

#9. Many investors rent out their condos and wait for a good time to sell. The rent income pays for the mortgage and its low risk. However if condo prices stagnate or prices drop it becomes high risk and they will be looking to sell in a hurry to prevent taking losses.

I could go on and on, but essentially the economy and housing market is a proverbial House of Cards and household debt/credit is the linchpin which holds it all together.

All it will take is a nudge to cause the collapse.

And here is the nudge that will do it:

Toronto currently has 148 high-rises and skyscrapers being built including 105 new condo buildings (and more scheduled for 2013 - 2015). Right now we are building 27,504 (a 14% increase), but there isn't the demand for it. When that extra 27,504 condos hits the market during the next 3 years it will cause condo prices to drop dramatically... which combined with household debt and people reneging on mortgages (or banks refusing to give them refinancing) will push a market correction.

So yes, household debt is the Achilles heel... but its too much condo supply during the next 3 years that is the ticking time bomb waiting to go off.

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