We can see that Japan peaked on house prices to income in 1989, at about 30 percent above the long-term average, and has been trending down ever since. The 1989 peak in Japan was not quite as stretched as the peak reached in the United States in 2005 and the current peak in Canada, both of which topped out at close to 40 percent above the trend line. This chart provides concrete evidence that Canada’s current bubble is truly egregious, not only compared to past housing price peaks in Canada but also compared to the housing bubbles that have appeared elsewhere. In other countries, when prices reached extreme levels such as Canada has now, a real estate crash followed, as can be seen in Germany (peak in 1980), Japan (peak in 1989), and the United States (peak in 2005).

      House prices in Canada as measured by a major annual survey are more than 40 percent overvalued.

      To get back to normal levels, a correction is needed that takes the house price/median household income ratio from above 5.0to below 3.0, which is approximately the same magnitude as the correction that happened in the United States. And a correction that big is called a crash, not a correction and definitely not a soft landing.

      But we know that Canadians are reluctant to believe that the real estate market is going to crash. We also notice that the media love to present various scenarios that would justify Canada’s current extreme house prices as within the range of normality because of unique circumstances that apply in Canada but not in the United States. So let’s try to find a factor or factors in the Canadian situation that make Canada a special case and could justify the current high prices for houses.

      One frequent argument that is used by those who wish to deny a housing bubble is the current state of interest rates. The assertion is: “as long as interest rates stay low, house prices cannot decline.” It is definitely true that extremely low interest rates in Canada contributed to the housing bubble. But any attempt to argue that low interest rates guarantee a permanent bubble does not work. Look at Figure 1.2 and examine closely the line that shows Japan’s house prices since 1989. House prices are 60 percent lower today than they were at the peak of Japan’s bubble. And for almost the entire twenty five years since ’89 Japan’s interest rates have been much lower than interest rates are today in Canada. In fact, the ten year Japanese government bond yielded less than two percent for the entire sixteen year period since 1998 and house prices continued to decline.

      Immigration and Foreign Investors to the Rescue

      Anyone who’s ever discussed house prices with someone from Toronto or Vancouver knows that residents of those major cities will respond immediately (if they own property themselves) by mentioning immigration or its close cousin, the foreign investor, to justify unusually high prices or signs of overbuilding as dozens of new condo towers dot the skyline. These homeowners justify high prices by pointing to the positive influence of non-Canadians and recent immigrants and their allegedly very deep pockets combined with their strong passion for owning Canadian real estate. As with most widely held views, there is some truth to the belief. Immigration is a key swing factor in household formation, as population growth without immigration would be much lower in Canada — closer, in fact, to the slower pace that exists in most other developed countries.

      According to Statistics Canada, the growth in Canada’s total population has been rapid compared to that of most other developed countries, varying between 0.8 percent and 1.2 percent annually for decades.[13] The rate of growth of the total population for Canada exceeds all other countries in the G7 , especially countries like Japan and France, because Canada has a relatively high rate of net in-migration. But since 1992 the annual rate of growth has never exceeded 1.2 percent, hardly enough to cause a housing boom. Australia, New Zealand, and Switzerland grew at faster rates, all above 1.2 percent annually.

      Our population growth surpasses that of the United States (0.7 percent), which had the second-highest rate of population growth among G7 countries and also had net immigration. Two-thirds of Canada’s recent population growth has been realized through immigration. This immigration flow is cited often as a key factor in the housing boom in Toronto, as that city attracts the largest percentage of immigrants to Canada. However, Canada’s rate of growth due to immigration is only slightly more rapid than that of the United States, and that country recently had a housing bubble and a crash. This deflates the argument pushed by Toronto condominium salespeople who love to talk about immigrants moving there and buying their product.

      There are other reasons to doubt the “immigration justification” argument for high prices. For example, the immigration explanation doesn’t hold up when we notice that cities like Winnipeg, Regina, and Saskatoon had even faster house-price increases in the last five years — places that attract very few immigrants compared to Toronto and Vancouver.

      Toronto is the preferred Canadian destination for immigrants. According to statistics published by the City of Toronto, it attracted fully one-quarter of all immigrants that came to Canada during 2001 to 2006, or about 267,000 people. Of course, the Greater Toronto Area (GTA) would have absorbed even more people. Toronto is home to 30 percent of all recent immigrants in Canada but only 8 percent of Canada’s population. But any cursory look at Toronto’s skyline (and indeed that of the GTA) shows that there is no shortage of recently-constructed units to fill that need. Immigration could only provoke a permanent housing shortage and a long-term plateau of elevated housing prices if somehow there were no new construction. But exactly the opposite is the case. Housing and residential construction in Canada is one of the biggest segments of the economy. Unless all those construction workers are building either the wrong kind of housing or in the wrong place for the people who want to buy, there is little chance that a booming flood of immigrants could push up house prices over the long-term.

      The foreign investor argument is equally problematic in explaining an excess of demand over supply, which might force prices higher. The facts on the ground are difficult to determine. Statistics are as elusive as the mythical foreign buyers who seem to be a major (unpaid) ally for every sales campaign for luxury condos in Toronto.

      We can’t track foreign investors as easily as immigrants since there is no record that identifies a house or condo buyer by occupation or country of residence or even type of buyer such as family, individual, or corporate. Most foreign investors in the Toronto and Vancouver areas, which are the areas with the most significant amount of foreign investment purchases, concentrate on the condominium market probably because there is little need for on-site supervision. Based on anecdotal evidence only, many condos in Vancouver and Toronto sit empty as investors choose to leave them unoccupied, at least in the short-term, because perhaps the plan is to flip the unit for a quick profit. This type of investment is really speculation, not investment if it is left empty because there is no income associated with owning the condo, only expense. Of course if it is rented it could be an investment, but a poor one since expenses normally exceed income in Canada’s condo market. The strategy that would yield a profit for the speculator is a sale that depends on finding a buyer willing to pay a higher price than the speculator. Of course, taxes and condo fees continue to eat away at the potential profit the longer the unit is held prior to flipping. It’s hard to imagine that foreign investor demand will be anything more than a temporary lift to the condo markets. It could go on for a few years but eventually foreign investors will move on to the next hot property market or they will sour on the Canadian economy or they will notice that their favourite speculation, the condo, is no longer rising in price and therefore not likely to yield any quick profits.

      But there is a more substantial, domestic and permanent source of demand for housing that might be a factor in the bubble, and that is young people who reach the age when they want to get married and move out of their parents’ home to live independently.