Unlike Britain and the US, Canada and Australia escaped a housing bear market during the global crisis ten years ago. They are now heading for long overdue and deep slumps, says Jonathan Compton. Elsewhere, Sarah Moore picks two property markets that are still worth a look.
Even as the Normans yomped ashore in 1066, the English unlike most of the continent already had highly developed property rights, which became embedded over the following centuries. By the 1600s, as the newly minted United Kingdoms of England and Scotland went on their global expansion spree, it exported its obsession with property ownership. Two nations in particular have remained property junkies: Canada and Australia. In each, the property market outlook is, at best, ugly.
The similarities between both countries are obvious. Each is the size of a continent, yet under-populated. Residential (and commercial) property prices have been rising steadily since late last century, with the 2008 financial crisis resulting in only a brief downturn as their governments and central banks reacted quickly, making money cheap and available. Lastly, each has banking systems largely closed to outside competition. This gives their banks cartel-like pricing and fatter profit margins, which helps shield the economies from the volatility inherent in being giant commodity producers.
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Canada heads for crisis...
Canada's residential market has an unusual model. It originally developed a system whereby most house buyers are forced to take out government-backed default insurance, thus passing the risk from the lenders to the taxpayer. This was similar to America until 2008, where investors assumed the key government-sponsored mortgage agencies known as Fannie Mae and Freddie Mac could always support the market. Both went bust. Even today, half of all Canada's home loans are insured. The result has been poor credit checking by lenders as there is no risk to their balance sheets. However, regulatory changes have unwound this cosy system, putting the risk back onto house buyers and the mortgage providers. The availability and price the interest cost of credit are the key drivers of all property markets, and in Canada both are worsening.
Housing supply has grown over the last two decades in response to seemingly ever-rising prices, with huge gains from Toronto to Vancouver. The house- price-to-median income ratios in the two cities are an eye-watering 12 and nine respectively.
Meanwhile, household debt has followed as investors bet on property. At 100% of GDP, consumer borrowing is amongst the highest for any developed nation. This was all very well with ultra-low interest rates, easy credit and booming immigration and commodity prices. But now all these trends have eased or reversed. The central bank is on the case and trying gently to deflate the bubble. This rarely works. The commercial banks are hideously overexposed and complacent. For example, provisions for property bad debts by the giant Royal Bank of Canada are absurdly low at less than 0.03%. The downturn has already started in several cities. Bank profits will be shredded.
... while Australia is going under
The Australian housing market is uglier. It started to turn down at the end of last year. The trend is accelerating. Sales of new houses, a sure indicator of future prices, have fallen to a 20-year low. Savings rates are close to their lowest level in nearly 50 years, yet there is no chance that lower house prices will attract new buyers, given that consumers have gorged on borrowed money: the household debt-to-income ratio is a world-beating 200%. The decline in prices this year has been 4% and worse in Sydney, the largest city; but this slide is accelerating.
The blame for the latter phases of the housing boom can be laid at the door of the Reserve Bank of Australia (RBA), the central bank. To ward off a recession during the financial crisis and the commodities downturn, it stimulated east coast construction. But it maintained very lax regulations over credit and lending.
Banks have become more circumspect, reining in loans and tightening lending standards. But they will become ultra-cautious following the The Royal Banking Commission on misconduct, established in 2017 owing to scandals emerging from the giant Commonwealth Bank of Australia. This has revealed gouging of clients across the board through hidden, excessive or unnecessary fees and charges, combined with lackadaisical controls. Meanwhile, the RBA, perhaps fearing a full-blown crash, is stoically holding its official cash lending rate at its all-time low of 1.5%. Yet given that Australian banks are massive borrowers in overseas markets, where rates are rising, so domestic rates must follow to make up for their higher foreign borrowing costs.
The property markets in both Australia and Canada are sick and are in for a prolonged squeeze. The falls are long overdue and will be steep. What cannot be forecast is the effect on domestic sentiment. But history suggests that after many years of easy gains, a reversal leads first to denial, then a panic rush for the door.
Jonathan Compton was MD at Bedlam Asset Management and has spent 30 years in fund management, stockbroking and corporate finance.
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