Doomsday looming for the Canadian real estate market, and the general sentiment
As I write this, most Canadian reit etf's have dropped hard alongside world markets following the coronavirus scare. The fear is that home prices may follow downward. Nobody is buying right now and to a large extent business countrywide has halted. Sentiment is dreary to say the least. Household debt to GDP reached an all-time high of %100 at the end of 2019, meaning on average Canadians borrowed twice as much as they produced. Not to mention, landlords can't evict their newly unemployed tenants for not being able to pay rent as a result of new legislation. Trudeau and the BoC are making desperate attempts to save real estate prices from plummeting by legislating bank mortgage deferrals for up to 6 months, an emergency drop in interest rates to encourage cheap lending, an $82 billion stimulus package to attempt to support those affected by the new circumstances, and a $200 billion quantitative easing program to buy government bonds to provide extra cash for institutions and the government.
Liquidity is a serious threat and an indication of the need for cash is in the credit market, interest rates spiked higher making it more lucrative to own corporate bonds as investors have rushed to sell their assets. The BoC's strategy to fight potentially drying up liquidity are lower interest rates, having decreased the prime interest rate to push down the competitive rates and to encourage cheap lending.
Unfortunately I can't see how these measures are going to successfully reverse the damage. The main issue is sentiment. History has shown that economics doesn't always make sense. Canadians can be in debt to their eyeballs and still do well if market sentiment is positive. In fact most have long been in net debt alongside the country and have simultaneously benefited from a positive upswing in all major sectors. This is the wealth effect in action. When people feel good they are more willing to spend money and do business regardless of their balance sheets. This can be stimulated by government programs, positive job reports, increasing real estate prices, low interest rates, and essentially anything that fosters positive sentiment.
However, the same can't be said for our current crisis. Right now there's a lot of uncertainty and the markets are unwilling to spend money and take risk. Extending credit will not solve the problem on its own. This is a panic that's shared across the world. Oil has dropped 65% in under 3 months, a key buffer of commerce and asset prices. Major indices have lost about a third of market value due to fear and investors are making a flight for cash. This is not the same as the 2008 Lehman crash, a liquidity crisis that did cause some panic but was then reversed by consecutive quantitative easing programs spurred by the federal reserve. This panic is medical in nature, and fear is deeply embedded in the intricacies of our everyday lives. With the world at a stand still, injecting liquidity into the market may not be enough to stop the deflationary forces at play. Those over-leveraged in debt are going to have a hard time and many may go bankrupt having lost their jobs. Homeowners will be hit hard, as the real estate market is built on mortgage debt, sales have declined and the demand to buy is not there.
Bottom Iine
Liquidity is a problem but the main driver is the unanimously shared fear in the current environment. While there remains uncertainty surrounding the COVID-19 pandemic, economic output will be hindered and a downward spiral will likely continue. Defaults and bankruptcies may be the new trend, and I believe the human nature to be austere in these circumstances will take over and set in motion a trend to save money and avoid risk, fostering a deflationary environment. The result would be the continuation of the market revaluing equities lower until sentiment changes.