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April 16, 2020 | Overdue Train Wreck Unfolding in Canada’s Highly-Levered Realty Markets

Danielle Park

Portfolio Manager and President of Venable Park Investment Counsel (www.venablepark.com) Ms Park is a financial analyst, attorney, finance author and regular guest on North American media. She is also the author of the best-selling myth-busting book "Juggling Dynamite: An insider's wisdom on money management, markets and wealth that lasts," and a popular daily financial blog: www.jugglingdynamite.com

As Canada’s manufacturing and oil sector shrunk over the last decade, real estate and residential construction became the economy’s largest sector accounting for 15% of GDP in 2019.  Low rates, lax lending and debt-enabling government policies helped Canadians to go on a self-destructive spending spree levering up property gains to extract more consumption and speculation all along the way.

In the process, Canadian households became the most indebted in the G7, owing $1.76 for every dollar of disposable income.  As I have noted in the past, households with the highest property values and incomes to be levered, also tend to owe the most debt.  Households in Vancouver and Toronto, with some of the highest average incomes in the country, and highest property prices in the world, owe a mind-blowing $2.30 and $2.09 of debt respectively for each dollar of disposable income and more than 50% of household income is needed for shelter costs alone. 

This kind of extreme leverage was always a train wreck waiting to happen, and COVID-19 is serving as this cycle’s derailing brick on the track.

Suddenly, properties that were set up as periodic vacation rentals are empty and incomeless, while many long-term rentals that were barely positive and negative-yielding–even with tenants–have also seen a stop in rents. A third of Canadian workers have filed for government income support in the last month alone.  In a letter to the federal government last month, Airbnb wrote that nearly a third of its Canadian hosts need rental income to avoid foreclosure or eviction.

Recessions that begin with highly levered businesses and households have historically been deeper and longer than average.  Today, Canada is entering its sharpest economic contraction on record owing a record $2.3 trillion in mortgages, credit card, and other consumer debt.  The math for owners, lenders and investors should be riveting.  See: Once called safer than gold, Canadian real estate braces for a reckoning:

The City of Vancouver fears it’s heading for insolvency after it surveyed residents and found that 45% of households say they can’t pay their full mortgage next month and a quarter expect to pay less than half of their property tax bills this year.

It’s a stunning contrast to 2016, when those lucky enough to own a detached house in the west coast city watched their net worth balloon on average by more than C$1,600 ($1,130) a day without ever leaving home. In one year, the city’s properties surged in value by C$47 billion, more than double the cumulative take-home income of all its residents…

“I think it is the Great Reckoning,” says Douglas Hoyes, a bankruptcy trustee in Kitchener, Ontario. “We’ve been in a period for so long where it didn’t matter what property you bought or how highly leveraged you were. Well, guess what? Now it matters.”

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April 16th, 2020

Posted In: Juggling Dynamite

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