What Would Happen If Canada's Real Estate Bubble Bursts?


Home prices in Canada are going off the charts, and even attempts to cool down the market has been met with limited success. Many people agree that this increase in prices is not sustainable, and that a correction is bound to happen down the line. However, how this correction will manifest itself is uncertain. Most are still banking on that ambiguous "soft landing" policy-makers have talked about for years; but what if a real estate market crash was to occur?

For reference, an example of a real estate market crash would be Toronto in 1989. The average cost of a home hit a 30-year high at $273,698 – then the bottom fell out. By 1996, the average had fallen to $198,150.

Admittedly, there are some owners who would be largely unaffected even if there was a housing crash. Someone who isn’t going to move and has a lot of equity in the house would be set back, but they wouldn’t be tied to monster mortgages and still have a financial cushion.

But housing isn’t just about prices, and a serious downtown may have greater implications for the economy.

Karl Schamotta, director at Cambridge Global Payments, predicts that unemployment would spike and made worse by people's reluctance to move for work because they are tied to mortgages for homes worth less than they paid. This would be bad for productivity, and make Canada’s economy less able to react to global changes. Predictably, the loonie would also fall, which would hurt imports while boosting exports.

A lot of this also depends on why prices fall in the first place. If it’s due to resolving housing supply issues, this may actually be positive for the economy. If it is due to a quick rise in interest rates, we may see a situation that is not dissimilar to the housing crisis in the United States a few years back. People would have to spend more on their mortgages, leaving them with less to spend elsewhere. Then a consumer-led recession would occur, where unemployment rises, people default, and housing prices decline. Of course, that’s the worst case scenario and many believe that it will be unlikely.

One key difference between Canada and the United States is that “everyone in this country is trying to slow down the market.” Benjamin Tal, deputy chief economist at CIBC World Markets says, “You don't have the situation where banks are seeing green and trying to maximize profits. In fact they are really trying to slow it down. Regulators are trying to slow it down and more is coming."