Submitted by Ben Rabidoux of Financial Insights
Primer #5: The role of demographics in Canada’s coming housing bust
I’d like to reiterate that the point of these primers is to explain
the big-picture factors that have shaped my opinion on the direction of
the economy in general, and housing in particular. So far we have
seen that deflation
and not inflation will be the dominant force over the next several
years as we have reached a point of peak credit and peak consumption in
the Western world. Beyond that is anyone’s guess, and the inflationists
and hyperinflationists may yet be proven right. But it won’t be in the
next few years, at least not in Canada. We’ve seen that real estate in
Canada absolutely is in bubble territory
when the data is considered rationally and compared to widely accepted
measures of fundamental value. We’ve seen that the two big drivers of
this bubble growth have been mass psychology
(how many times have you heard, “real estate only goes up,” despite all
the contrary evidence just south of our border) and also by the
erroneous and self-defeating policies of CMHC.
We’re once again looking at one of the macro factors that will exert
significant downward pressure on real estate prices over the next
several years: demographics.
Let’s start by noting that Canada has a population pyramid similar in many ways to other mature economies. The population of Canada is aging: the median age in Canada increased from 35.2 years old in 1996 to 39.3 years old in 2008.
This results in a larger share of the population getting closer to
retirement. This is largely caused by the most notable feature on the
graph below, and the one we are particularly interested in: the bulge in
the middle of the pyramid.
I’m sure most of my readers are quite familiarized with this bulge
and with the name given to the group of people who make up this
anomaly: The Baby Boomers.
Baby Boomers is the name given to a group of people born between 1946
and 1965. Some simple math tells us that if you are currently between
the ages of 45 and 64, you have a lifetime membership in this club.
Right off the bat, let’s identify two important facts about the ages
of 45 and 64. Next year the oldest Baby Boomers turn 65, marking the
traditional end of their working years, and with it a shift away from
spending earned income to spending a retirement income that is usually
significantly less. Also next year, the youngest Baby Boomer turns 46.
During the typical working life, spending increases throughout the
early working years until…..age 46. At this point spending begins to
decline while saving and debt repayment accelerates.
The effects of an aging population and this housing life-cycle can be seen in the following charts from CMHC.
Note that 59% of homeowners currently live in larger houses that
their previous house, while 32% of home purchasers in 2009 indicated
that they purchased their home because they wanted a larger home. This
would be expected as a population ages and approaches its peak interest
in large homes. There is also a sociological element to all of this, as
average home sizes have moved higher across all age groups over the
past several decades. Nevertheless, I believe the era of the McMansion
is over, as you will see below.
As we noted in our first primer, because of the nature of our
fractional reserve banking system, we need a continually-expanding debt
base to service existing debt, as that debt must be repaid with
interest. When demand for debt diminishes and when that diminishing
demand is coupled with increased savings, it causes deflationary
pressure as both the monetary aggregate and velocity of money decline.
The impact of deflationary pressures on housing prices have been
described ad nauseum on this blog. So we’ll leave it at that for now.
But keep that in the back of your mind as that is the macro picture that
will be working behind the scenes here in Canada over the next several
As of early 2010, real estate provided 48% of the net worth
of Canadian households, the highest it had been in 20 years. I would
bet that number is quite likely north of 50% today, though I can’t
prove it. Below is a chart taken from the October 2009 Moneysense
magazine, in which they profiled the net worth of Canadian households.
Net worth was measured as assets minus liabilities, where assets
included home equity; financial assets such as stocks, bonds, and mutual
funds; savings and bank accounts; and accrued pension benfits. What I
want you to notice is that net worth for the 55-64 age group peaks at
roughly age 60. The median net worth at this time is a little over
$420,000. At closer to 65, net worth drops below 400K.
Some simple math tells us that well over 50% of Canadian households
between the ages of 55 and 64 have a net worth of less than 400K.
Putting that fact together with the one above, it implies that there are
50% of households in Canada facing retirement with an asset allocation
of approximately $200,000 or less in home equity and $200,000 or less in
financial assets. The picture may be even bleaker depending on the
methodology used in the Moneysense wealth test. If they included such
non-financial depreciating ‘assets’ such as a car or household items,
the numbers could be even lower. Here’s the point: A massive group of
Canadians are nearing retirement and are completely unprepared for it
Let me put it another way. In 2009, this cohort of 55 to 64 year old individuals represented a total population of over 4 million, or over 12%
of Canada’s total population. Accounting for some one-adult
households, this represents over 2 million Canadian households. Since
the median line represents the 50th percentile, it means that there are
over 1 million households facing retirement in the next few years and
evidently planning on having less than 200K sustain two people for the
next 20 years. Given the extremely low interest rate environment, that
won’t throw off much, perhaps 10K per year if you’re willing to take a
bit of risk. I don’t know what that lifestyle will buy exactly, but it
will certainly involve significantly less discretionary spending and/or
an acquired taste for Purina in a can.
Not only are they not prepared in terms of liquid financial assets,
but increasingly, people are entering retirement years with significant
debt. Since the early 90s, the rate of insolvency among Canadians
over 55 has shot up by more than 500%. The fact that more and more
Canadians are reaching the end of their working lives encumbered by
debt is a worrisome trend. It seems that as the boomer generation edges
into their 60s, a significant number are finding themselves
unprepared for retirement.
It should be obvious that there are many boomers expecting to free up
the equity in their home to finance their retirement. Currently,
nearly 75% of people in the 55-64 age group own their home, meaning that
based on my crude calculations, we are looking at approximately 750,000
households faced with the option of either freeing up home equity or
significantly delaying their retirement plans. If someone can find hard
stats that either support or refute my crude analysis, I would love to
There are several ways to free up home equity:
1) A reverse mortgage. In Canada, CMHC will provide these mortgages through the Canadian Home Income Plan.
It will give you up to 40% of your home equity as a loan. The
principal and accrued interest are payable either upon the death of the
mortgage holder or upon sale of the residence. I have no doubt that
this option will become an increasingly popular way to free up home
equity. Between 2004 and 2008 compound annual growth at Toronto-based
HomEquity Bank, Canada’s leader in reverse mortgages, was 12%.
This approach to freeing up equity should have the least impact on the
housing market. However, the total number of homeowners opting for this
approach is still tiny; In the past 20 years, CHIP has issued
approximately $770 million in reverse mortgage loans to to only 12,500
clients. If my math above is correct and there will be over 750,000
households that need to free up this equity, this will represent a drop
in the bucket!
2) Sell and rent. Given that the notion of housing being the ‘safest investment’ is heavily ingrained in the Canadian boomer psyche, I think it is a fair assumption that only a small percentage of boomers will opt for this.
3) Downsize. Here is where I believe the majority of boomers will
attempt to free up their equity. The idea is simple. Sell the huge
McMansion that now requires too much maintenance and is too large for
the needs of the near-retirees; buy a smaller home or condo. Pocket the
difference. Live the dream!
Several new reports from CMHC lends credence to this. In one report,
CMHC highlighted the percentage of household undertaking major
renovations. The results were then displayed based on the age of the
From the report:
“The most common reason provided for renovating was to update, add value or prepare to sell.
In light of these findings, it shouldn’t come as a surprise that those
aged 55 and over represent the largest share of intending home
purchasers in 2010 – which provides a window for who’s behind the recent
rise in listings.”
Note that some of the largest increases in home purchase intentions were in the 55-64 and 65+ age groups. So what were they buying?
I believe that this absolutely is a trend that will continue. The net effect of this will be two-fold:
1) Price compression in the real estate market, particularly in larger, multi-floor homes.
2) A price floor under smaller residences, particularly small
bungalows (2 bedrooms) with smaller yards. In markets where condo
speculation and overbuilding are not rampant (ahem….Toronto!), this may
also put a floor under condo prices.
I’m confident that this boomer downsizing will be a dominant theme in
real estate for the next decade. The great unknown, of course, is just
how many are counting on their home equity for their retirement. How
will they react to the headlines about year-over-year declines in real
estate values? Will they sit tight like in the Fall of 2008, expecting a
rapid bounce? Or will they all reach the conclusion and in a wave of
panic selling try to catch the peak, spurred on by all the media talk
about a housing bubble?
As Isaac Newton famously said, “I can calculate the motion of the
heavenly bodies, but not the madness of men”. And so it is with our
ingrained animal spirits.
The great danger in having such a large group dependent on one asset
class to fund their retirements is that they may act en masse in trying
to free their equity, leading to self-feeding beggar-thy-neighbour
behaviour of price reductions amid surging inventories.
We may well see an orderly liquidation and downsizing, but it’s one
more mine in the great minefield that is the Canadian real estate
market. Tread lightly!