Tough markets bring tough questions

Question: Can housing prices in Canada go the same way as in the US?

Just when we thought housing prices south of the border couldn’t get any cheaper (everybody knows somebody pondering the idea of buying a place in Florida these days) we find out that foreclosure activity in April was up a big 32 per cent year over year, a new record high. Though some of the increase is no doubt due to a moratorium on foreclosures placed on major banks and government agencies having now come to an end, there is a growing concern that we don’t fully understand the severity of the number of foreclosed homes not yet brought to market. With unemployment numbers expected to head towards double digits, one should be open to the idea that the US economic recovery may well continue to face some challenges. Here’s a scary stat from Realty Trac, an online foreclosure market place information site – in Nevada, one in every 68 homes is now in foreclosure. To be sure, the Nevada rate is five times that of the national average and is clearly an aberration, but it does demonstrate how bad some pockets of the US are faring at the moment.

All of this leads me towards answering a question on many Canadians’ minds today – Could Canada ever see a housing crisis similar to that of its U.S. neighbour? Before providing my opinion, we first need to have a better understanding of what it is that created the US housing problem. Following the dot com crash and terrorist act of 2000-2001, the US was perceived at risk of an economic slowdown. In an effort to bolster the economy, the US Federal Reserve lowered short-term interest rates to 50 year lows. In so doing, they increased the affordability of housing – the lower one’s interest cost, the more one could afford to spend on a home. As interest rates fell, housing prices rose, American confidence levels grew, and a rush to refinance mortgages at lower interest rates was on. In addition, speculative activity (whereby one buys a home only to quickly sell it at a higher price) took hold on the belief that prices could only go one way – up! Perhaps of most importance is the fact that all eyes were on the short-term benefit of making the sale -- a new deal meant closing fees to the bank and because banks would quickly sell the mortgage off to a third party, little attention was paid to whether the buyer could actually afford the home being purchased. In essence, there was little concern about the potential for default, as nobody could be held accountable.

Could the same happen here? It’s not that we can’t all succumb to greed and dream that housing prices will rise uninterrupted forever. Our banks simply won’t let us! Canadian lenders, namely banks, will never permit home valuations to reach such lofty, unsustainable levels. Canadian banking rules are rigid and safeguard us from the abuses that took place in the States. Unlike their U.S. counterparts, Canadian banks keep the loans they provide on their books. As such, they are careful to ensure home buyers can afford what they purchase. For example, an important qualifying criteria is that of the debt/service ratio whereby ones monthly mortgage payment plus taxes and heat cannot make up more than 32 per cent of gross income.

Moreover, If you’ve ever gone through a credit application, you probably know all too well the trouble the banks put you through to get approved – T4 slips, confirmation of assets, credit history etc. Simply put, we are not permitted to buy more than what we can afford. This is why Canadian banks have come out of the world-banking crisis with perhaps the finest reputation amongst banks worldwide and it is why we continue to enjoy a solid housing environment here in Canada.

Chart of the Week – The Canadian dollar

The recent strength of the CAD dollar merits some attention this week. It’s an important topic as investors generally invest in US equities as a means of diversifying their portfolio, and in doing so have exposure to the exchange rate. And while the short-term movement of the currency is not in itself a reason to go out and make dramatic shifts to one’s asset mix, it should nonetheless be part of the decision making process.

The direction of the CAD dollar also plays into the discussion on housing as it relates to Canadians looking to scoop up a steal South of the border. To purchase U.S. property, one must first buy U.S. dollars. Our team has actually come across a few clients lately who, during a financial planning process, were looking to buy property in Florida.

When asked our opinion, the main concern we expressed was that of the currency exchange rate. We explained that the perceived savings from low U.S. housing could potentially be offset by a higher CAD dollar. One thing we suggested as a way to minimize the currency risk would be to borrow the funds needed in US dollars. Then, gradually convert CAD dollars to U.S. dollars to pay off the loan. In so doing, one averages out a rate over a period of time, thus reducing the potential risk of a quick move in the dollar turning a major purchase into a financial headache.

We’ll address the concerns surrounding the U.S. dollar in next week’s write-up.

Have a great week!

Robert T. Moore is an Associate Portfolio Manager and Wealth Advisor with ScotiaMcLeod in Pointe Claire, Quebec. Opinions expressed in this column do not necessarily reflect the views of ScotiaMcLeod or any of its affiliated companies. It is recommended that individuals consult with their own financial advisor before acting on any information contained in this article. Robert Moore can be reached at www.moorerasponi.com

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