The Strategist

Canada's real estate bubble is not going to burst...yet

06/05/2017 - 15:32

A month ago it became known that the housing bubble in Vancouver has grown bigger than ever. The situation worsened at the end of May.

A year ago, the authorities established a property tax of 15% for foreign buyers. At the same time, Chinese investors, who seek to legalize their funds as safely and effectively as possible, are providing the main inflow of funds to the real estate market. Prices for individual houses and apartments rose to new record highs.

According to the council of real estate, prices are distributed approximately as follows:

Last month, condominiums were priced at $ 571,300 thousand. The sum has jumped by 17.8% for the last 12 months, and now it is by 3.1% higher than in April 2017;

A block’s price was $ 715,400 thousand, 13.1% more than a year ago, and showed growth of 1.9% compared with April 2017;

The price of a single-story house was $ 1,561 million - an increase of 3.1% over the past 12 months and an increase of 2.9% compared to April 2017.

The only fall noted in May is a decrease in the number of real deals. 4 769 transactions were concluded in May 2016, yet there was just 4 364 of them in May 2017 (a decrease of 8.5%).

In other words, everything that the introduction of income tax was allowed to achieve by 15% - a sharp decrease in the number of transactions. And since traders were desperate to find more aggressive buyers, they were incredibly happy when a new wave of buyers appeared, and when they slowly but surely started accepting all available offers.

Perhaps Canada was lucky that the attempt to deflate the bubble in the real estate market in Vancouver failed. Otherwise, it would spread throughout the country, leading to a historic collapse in value and huge defaults.

The result would be devastating for the Canadian banking sector. This, of course, does not mean that the problem in Canada has been solved, it has simply been delayed thanks to Chinese buyers who prefer to keep their money in Canada, rather than at home.

Recall that shares of Home Capital Group collapsed by more than 60% in the last week of April, as the company reported raising an extremely credit line of 2 billion Canadian dollars ($ 1.5 billion) to provide liquidity.

This became necessary in conditions of outflow of deposits, and if the trend continues, soon the alternative Canadian mortgage lender will be unable to fulfill its financial goals and will become simply insolvent. The Canadian mortgage bubble will finally burst.

Conditions on the credit line are far from ideal. Home Capital will pay 10% per annum on outstanding balances and a non-refundable commission fee of $ 100 million Canadian dollars, the reserve fee for unused funds is 2.5%. The effective rate starts at 22.5% when using 1 billion Canadian dollars, and then drops to 15% if the funds are fully selected.

And this is a very expensive credit line. It is unlikely that it will help, given the challenges ahead. Home Capital reported a sharp drop in balances on savings high-yield accounts in the domestic trust fund, the rate from March 28 to April 24 fell by just $ 591 million, and the total balance was $ 1.4 billion. The company has already warned investors that the outflow will continue.

That is, the bank has ceased to be a bank for depositors, and now the race begins for someone who will soon be able to withdraw their money.

A rate of 22.5% means that the company's days are numbered and it will very soon be declared bankrupt.

Home Capital’s new management, which is to be changed after the scandal, also will also have to "avoid bankruptcy within three months." That is, in three months someone will receive a "golden parachute", the company will become bankrupt, and a full-fledged crisis in the housing market will begin in Canada.

Its consequences, of course, will not be as large as it happened with the United States in 2008-2009, but the very possibility of repeating such a situation clearly shows all the risks. The market, regulators and many investors have very quickly forgotten how neglecting rules and elementary financial logic can very quickly lead to a collapse.