Playing with 'house money'
On the surprising lack of mortgage debt
One of big questions around Canadian housing is “how are people affording these prices???”. It’s usually rhetorical, but I think it’s a good question. How is it possible that buying a home in Toronto and Vancouver sucks up 80%+ of median income?
First, very few people are homebuyers in any given year. In 2022, 500,000 homes were sold across Canada. Compared to 15,000,000 total homes, that means only about 3% of homes traded hands at all. Super roughly, you can take that to mean about 70% of homeowners bought their home over 10 years ago. Home prices are a reflection of a thinly traded market.
But maybe more importantly - most people are not homebuyers, but homeowners. Rising prices do not worsen affordability for homeowners, it improves affordability (relative to non-homeowners they compete with). About half of home purchases are first time home buyers - the remainder being repeat buyers and investors.
This brings me to a surprising data point. In 2013, the CMHC reports that the average new mortgage balance was $213,000, compared to a average house price of $375,000. Today, the benchmark house price is $750,000, but the average new mortgage: $315,000.
Home prices have risen by $375,000 (7% per year), but mortgages have only risen by $100,000 (4% per year). There are some caveats for data folks below1.
The CMHC dataset also includes CMAs. Across cities, house price growth is a tremendous predictor of mortgage size growth (not surprisingly). However, the correlation is not 1:1. New mortgages grow less than house prices.
To me, this highlights how existing homeowners are able to use their increased home value to pay more for homes. When your home value goes up, you might not feel richer, but you can sell and buy a more expensive home. If you were the only homeowner in town, that’s awesome, since you’ll have a big down-payment available for an upgrade. But if most people are also homeowners, then it’s a bit self-defeating (since you are going to compete with other homebuyers who also have homes to sell).
It feels like a wash but it does create a strong cycle of rising prices pushing prices even higher. In the stock market, stocks that go up…tend to continue to go up, a phenomenon called momentum.
Momentum is powerful in housing. It’s also amplified by banks - who understandably are eager to lend more to folks who have valuable assets (like a house with a mortgage much smaller than current value). You might get nice offers for a HELOC (home equity line of credit), which lets you access that new equity without even selling - maybe you could use that as a down-payment on another home! Or you can help a child with their down-payment, which is increasingly common across the GTA and Vancouver.
Looking across Canadian cities, London, Ontario stands out. In 2013, the average new mortgage tracked to about 80% of average house prices in London. But today, new mortgages ($316,000) add up to only half the average house price ($625,000). London itself hasn’t changed all that much - but it has been deeply affected by outflows from Toronto (spurred by “drive till you qualify”). Momentum affects local house prices, but it also spreads, as would-be buyers from high house price regions decide to move to regions with lower house prices (see Southwestern Ontario, Halifax, Calgary more recently).
What’s the takeaway?
There’s no secret sauce to how “people are affording these prices”. The vast majority aren’t. I’d guess less than 5% of homeowners have bought their first home at COVID era and beyond prices (~1.5% of homes per year are bought by first time home buyers)
If you don’t own, try not to be too tough on yourself. Prices have been bid up in a sort of deranged musical chairs that basically only makes it feasible for homeowners to participate. Of course, high earners can always buy their way in, but the median person, and many beyond the median, are priced out.
Most homeowners can comfortably stay in their current homes (with their lower mortgages), but the market needs some amount of new entrants to support prices. Given our housing shortage, we’d expect that to be at stretched prices, but mortgage costs of 60% of median income are not a reasonable equilibrium I.M.O., not without ongoing momentum effects from rising prices.
What if it stops? What if house prices start falling or stop rising? There is increasing chatter among real estate folks that many homes in the GTA seem unable to sell. If you can’t sell (at a satisfactory price), you can’t buy either. Momentum works in both directions - and the crazy overshoot on the way up raises the risk of an eventually stronger decline.
Yikes, that feels dark. But I think the good news is that we’ve see this game of musical chairs before (see the first chart), and it was mostly “fixed” within a few years. It is always possible that hunkering in for a few years will bring much better conditions for housing affordability. Meanwhile, it’s quite hard to imagine it getting worse - though I’ve been wrong about this for years now.
I’ll note that I’m mixing datasets here, and the CMHC data might only represent insured borrowers (higher ratio but capped at $1M). Still, Canada has $1.7 trillion in mortgage debt across 5.9 million households with mortgages, meaning the average mortgage carries a $300,000 balance. I think my data is understating the average new mortgage, but it is the data I have.