David Rosenberg: Canada ranked world’s second frothiest housing market


Exercise caution investing in the Canadian dollar, New Zealand kiwi and Swedish krona

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By David Rosenberg and Julia Wendling

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The global housing bubble’s ascent to greater heights continued unabated through the first half of 2021, running way ahead of its underlying fundamentals. Indeed, according to data from the Dallas Fed, the Global House Price index is now up 10.6 per cent on a year-over-year basis and a reversion to the long-term trend line would imply an incredible 12.9-per-cent correction (for some perspective, at the peak of the mid-2000s housing bubble, a reversion to the mean would’ve only yielded a 9.8-per-cent setback).

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The remarkable growth is even more stark in real (inflation-adjusted) terms, as global residential real estate prices have shot up 8.1 per cent year over year — the highest yearly growth rate on record and well above the 5.5-per-cent year-over-year peak in the second quarter of 2005. With most of the world pulling away from monetary stimulus, we decided it was time to take a look at which countries’ housing manias are most at risk of a pullback if interest rates continue their move higher.

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That said, there are some large divergences across countries. For example, Canada and New Zealand have seen real house prices spike by more than 20 per cent from year-ago levels, but they’ve actually deflated in Spain and Italy (by 1.7 and 0.2 per cent, respectively), highlighting that the risks of a correction are much more pronounced in some countries relative to others.

To compare the extent of housing bubbles across various key economies, we decided to rank countries according to four variables: home price-to-rent ratio, home price-to-income ratio, household debt to GDP and the 10-year compounded annual growth rate of real house prices. The scores were then averaged to create an overall rank (where “1” means the largest bubble). The results are reported in the accompanying table.

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The home price-to-rent ratio measures the relative affordability of owning versus renting (the higher the score, the more expensive it is to own). Based on this metric, Canada, New Zealand and Portugal scored the worst, with ratios above 140 per cent (considerably higher than the average of 126 per cent). On the other end of the spectrum, relatively lower readings in Italy (101 per cent) and South Korea (107 per cent) suggest home prices there have grown at a pace roughly in line with rental growth acceleration since 2015.

Next up is the home price-to-income ratio — another measure of housing affordability — which is calculated by dividing nominal house prices by disposable income per capita (where lower values also reflect a more affordable environment). Once again, Canada (130 per cent), New Zealand (135 per cent) and Portugal (134 per cent) top the list, joined by Germany (133 per cent), which has also seen house prices surge by more than 30 per cent relative to disposable income since 2015. As was the case with the home price-to-rent metric, Italy (98 per cent) and Korea (97 per cent) scored at the bottom and, with ratios under 100 per cent, actually show the price tag on dwellings has fallen in comparison to disposable income over this period.

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The next metric — household debt to GDP — measures consumer debt (mainly mortgages and consumer credit) as a share of total economic output and helps us gauge the extent to which each country’s residential real estate market is exposed to the recent backup in interest rates as many central banks switch gears to less accommodative environments. Countries with a larger household debt ratio will experience a greater hit to consumer spending (as debt-servicing costs and mortgage rates rise) than those with lower household debt-to-GDP ratios.

Based on this metric, Switzerland (133 per cent), Australia (120 per cent) and Norway (111 per cent) are most vulnerable, with ratios well above our sample average of 87 per cent. Conversely, Italy (53 per cent), Germany (58 per cent) and Greece (62 per cent) screen quite well according to this metric.

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Finally, we also looked at the 10-year compounded annual growth rate (CAGR) of real house prices to assess which countries have experienced the largest housing market price gains. The top three based on this measure include New Zealand (7.2 per cent), Canada (4.2 per cent) and Sweden (4.4 per cent), all of which have posted home-price growth well above their longer-term averages and double the sample mean of 2.2 per cent. In contrast, house prices have deflated over this time frame in Greece (-2.6 per cent), Italy (-2.5 per cent) and Spain (minus one per cent).

Based on a combination of these metrics, we found that New Zealand had the highest average rank (indicating its housing market is the frothiest of the group), followed closely by Canada and Sweden. The Reserve Bank of New Zealand is imposing stricter mortgage lending rules in an effort to cool down the overheated housing market (effective as of Oct. 1), so it will be interesting to see if the central bank’s efforts to rein in the price surge are effective over the coming quarters.

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On the flip side, countries such as Italy, Greece and Japan have had fairly tepid housing market growth and are, therefore, less at risk of any pullback based on our analysis. It is important to note, however, that all three countries are facing unfavourable demographic trends, which could continue to act as a drag on housing market growth.

The bottom line is that investor caution over the risk-on trade is warranted as the recent backup in interest rates is likely to hit many economies hard via a turn down in consumer spending due to the “wealth effect” if the shifts in central bank policy mean-revert asset ratios, in this case, the residential real sector — particularly in New Zealand and Canada where both central banks have announced the end of their quantitative-easing programs and the intent to initiate rates tightening cycles earlier than expected.

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In addition, we advise investors to exercise caution investing in currencies such as the Canadian dollar, New Zealand kiwi and Swedish krona (despite tailwinds persisting over the near term), because these economies remain exceptionally vulnerable to the impending mean reversion of housing prices.

Financial Post

David Rosenberg is founder of independent research firm Rosenberg Research & Associates Inc. Julia Wendling is an economist there. You can sign up for a free, one-month trial on Rosenberg’s website.

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