This article was originally published on BloombergBusiness here. By Katia Dmitrieva. Updated June 3rd. 2015.
Plankton and Other Reasons Canada Housing Won’t Crash
Stuart Levings, head of Genworth MI Canada Inc., the country’s largest private mortgage insurer, has a message for U.S. investors: red hot housing markets in Toronto and Vancouver aren’t about to plummet.
The chief executive officer has his work cut out for him. Figures Tuesday showed Vancouver prices soared 9.4 percent in May from a year ago and the average price of a detached home reached a record C$1,417,409 ($1,143,994). In Toronto prices rose 11 percent on average to C$649,599.
Prices are up 71 percent nationwide over the past decade, prompting organizations from the International Monetary Fund to the Bank of Canada to label the market overvalued, and investors such as Steve Eisman, of Neuberger Berman Group, to have shorted housing stocks.
Levings maintains the market has solid underpinnings and is traveling to the U.S. to make his case. Here’s his argument:
1) The Canadian Real Estate Ocean Is Full of Plankton
“We look at the housing market like a food chain,” Levings said in an interview at Bloomberg’s office in Toronto May 28. “The first-time homebuyers are really the plankton. And if you don’t have plankton in the ocean, you’re going to eventually starve out even the big whales and the sharks. You need that first time homebuyer to buy that home so the next person can move out to buy their own home.”
The demand comes from millennials and the roughly 250,000 annual immigrants buying their first property, according to Levings.
“There is strong demand in this country and there will always be,” Levings said. “Why? Simply because of our immigration policy. We bring in first-time buyer pipelines through our immigration policy. They are great future first-time homebuyers that become plankton.”
2) Mortgage Regulations Worked
The federal government has introduced several mortgage rules since 2008 to take the froth off heady real estate markets. Shorter amortizations and higher down payments have kept the riskiest of buyers out of the market, Levings said. Average credit scores of Genworth customers remained steady at a high 737 points.
The trick is for the government to keep this balance and avoid making further changes that will entirely squeeze out first-time homebuyers and poison the food chain, Levings said. Outside Vancouver and Toronto, markets have cooled.
“We’ve squeezed the first-time homebuyers down into a small group who are qualified, good-quality borrowers,” he said.
3) Where’s the Correction Catalyst?
For a major correction to take place there needs to be forced sales, Levings said. During the 2008 financial crisis in the U.S., mortgages often became bigger than property values, so owners walked away from their homes.
“We don’t see the herd mentality in Canada that we’ve seen in other markets,” Levings said. “Even in the 2008 crisis in Alberta, where prices dropped 25 percent, we did not see people walking away.”
Unlike in some U.S. states, mortgages are typically “full-recourse” loans in Canada, which means the borrower continues to be responsible for repaying the loan even in the case of foreclosure. Lenders can take legal action to recoup the money.
Furthermore, low interest rates keep the plankton alive. The Bank of Canada has held its overnight policy rate at 0.75 percent after a January cut and banks followed suit with mortgage reductions.
4) Oil Slump Not a Big Issue
Housing sales in Calgary dropped 28 percent in April from a year ago and prices have dipped 1.5 percent since November as the oil industry cut thousands of jobs.
Levings said the reality on the ground isn’t as dire as people imagine. In meetings with brokerages and equipment-servicing companies in the province, Levings said he’s learned that many companies have opted instead to retain employees but pay them less. Albertans continue to pay their mortgages. The delinquency rate is still below 0.1 percent in the province, according to the company’s financial documents.
5) Subprime Minuscule
While some estimates of the shadow banking industry range as high as 10 percent, Levings said it’s lower and too small to matter. The non-federally regulated lenders only make up about 2 to 3 percent of home loans in Canada, according to Levings, who arrives at the estimate from conversations with lenders.
Growth in the sector, which includes mortgage investment corporations and private lenders, has picked up since tighter mortgage rules have pushed borrowers with low income and little documentation from the banks.
“It’s like the flea on the tail of the dog,” Levings said. It’s not going to cause a problem in its current state. When you get to the situation where like in the U.S. it got to as high as 30 percent, you’ve got a very big issue on your hands.’’