Is there a Canadian Real Estate Bubble?

It’s all over the media, doom and gloom, chicken little: “The sky is falling”

But is Canadian Real Estate really in a bubble?

To determine if Canadian Real Estate is in a bubble or not, you have to ask yourself: What is Canadian Real Estate Really worth?

Factor #1: Intrinsic Value

In the world of investing, there is something called intrinsic value: What is this item actually worth?

Gold has intrinsic value, pork bellies have intrinsic value, silver, wheat, corn, land, buildings, collectibles, antiques, everything has an intrinsic value and this is what Warren Buffet, world’s richest investor has made his entire career off of. He buys great companies and stocks below intrinsic value.

The question is, what is Canadian Real Estate actually worth?

In the Real Estate economics, intrinsic value is usually what it costs to build a property. In real estate economics, a rational buyer would never pay more for a property than it cost to build.

However, real estate economics don’t really apply in real life because buyers of residential real estate and residential renters are NOT acting rationally. Residential real estate renters and buyers purchase real estate on an irrational basis.

That’s why riverfront properties are worth more, better views are worth more, better design sells for more: Real estate is an irrational business, which leads me to my next point:

Some analysts claim that Canadian real estate is 30-60% overvalued and as a full time professional investor, I would agree with this claim.

When you look at what you can purchase in the United States for the same amount of money, Canadian real estate is way overvalued, even with the Canadian currency being way under par.

In real estate, the intrinsic value of a property is usually measured by dollars per square foot. Retail real estate in many Canadian cities is trading at the following prices:

Vancouver: $800 per square foot
Toronto: $600 per square foot
Winnipeg: $220 per square foot
Calgary: $400-500 per square foot
Edmonton: $375 per square foot

To build a regular house in many places is anywhere from $110 to $200 per square foot. To get into high rise concrete construction you have to be trading at $400 square foot and above to make the construction make sense.

When you start seeing prices above the cost to build, that is where you have to start wondering “Is this overvalued?”.

Factor #2 The Fundamentals

Many real estate experts in Canada claim (most of which are property brokers who benefit when you buy) that there is NO bubble in Canada because of strong fundamentals.

The argument is: Canada has strong fundamentals, people are buying, therefore there is no bubble.

In history, there was a phenomenon in Holland called “tulip mania” Wikipedia describes it better than I can:

Tulip mania, tulipmania, or tulipomania (Dutch names include: tulpenmanie, tulpomanie, tulpenwoede, tulpengekte and bollengekte) was a period in the Dutch Golden Age during which contract prices for bulbs of the recently introduced tulip reached extraordinarily high levels and then dramatically collapsed in February 1637.[2] It is generally considered the first recorded speculative bubble (or economic bubble),[3] although some researchers have noted that the Kipper-und Wipperzeit (literally Tipper and See-saw) episode in 1619–22, a Europe-wide chain of debasement of the metal content of coins to fund warfare, featured mania-like similarities to a bubble.[4] In many ways, the tulip mania was more of a hitherto unknown socio-economic phenomenon than a significant economic crisis (or financial crisis). And historically, it had no critical influence on the prosperity of the Dutch Republic, the world’s leading economic and financial power in the 17th century. The term “tulip mania” is now often used metaphorically to refer to any large economic bubble when asset prices deviate from intrinsic values.[5]

In Europe, formal futures markets appeared in the Dutch Republic during the 17th century. Among the most notable centered on the tulip market, at the height of Tulipmania.[6][7] At the peak of tulip mania, in March 1637, some single tulip bulbs sold for more than 10 times the annual income of a skilled craftsworker. Research is difficult because of the limited economic data from the 1630s—much of which come from biased and very speculative sources.[8][9] Some modern economists have proposed rational explanations, rather than a speculative mania, for the rise and fall in prices. For example, other flowers, such as the hyacinth, also had high initial prices at the time of their introduction, which immediately fell. The high asset prices may also have been driven by expectations of a parliamentary decree that contracts could be voided for a small cost—thus lowering the risk to buyers.

The 1637 event was popularized in 1841 by the book Extraordinary Popular Delusions and the Madness of Crowds, written by British journalist Charles Mackay. At one point 12 acres (5 ha) of land were offered for a Semper Augustus bulb.[10] Mackay claims that many such investors were ruined by the fall in prices, and Dutch commerce suffered a severe shock. Although Mackay’s book is a classic, his account is contested. Many modern scholars feel that the mania was not as extraordinary as Mackay described and argue that not enough price data are available to prove that a tulip bulb bubble actually occurred.[11][12][13]

There have been several bubbles throughout history in every asset class imaginable, even tulips! Which are not even considered an asset today.

When asset prices deviate from intrinsic values, that is when a bubble occurs.

Right now, I buy crack houses in Winnipeg, full of junk, mattreses, bed bugs, needles, smashed and trashed that are 100 years old for $100 a square foot.

I challenge you to go onto and look at what you can buy in American cities right now for $100 per square foot.

To calculate the square foot costs you take the value of the house aka: $100,000 divided by the square footage, lets say 1000 square feet, will give you the per square foot cost. So a $100,000 house that is 1000 square feet is trading for $100 per square foot.

Right now as I am typing this, I buy 1-2 homes a week in Winnipeg for a WHOLESALE price of $100 per square foot and RETAIL them (aka flip them) for $200 per square foot.

You have to ask yourself, why is a 100 year old crack house worth $100 per square foot when you can get a much newer beautiful home in the United States for that price? These are 2017 numbers which are much higher than 2008 crash numbers.

The fundamentals in Real Estate are generally 3 things:

Industry – Are there good solid jobs in the area?
Net Migration – Are people moving in?
Transportation – Can people, goods and services get to the area easily?

The industry in Canada is relatively strong, however, we are an oil economy and oil is under $50 a barrel at the time of writing. In Alberta in the oil sands, they need oil to be $80 a barrel or so to make money, that shuts down a lot of Alberta’s economy and by default makes our dollar weak. When oil was high, the US dollar and Canadian dollar were on par, if oil is down, the country is down.

Generally though, I would say Canada has a fairly strong economy and I think it will continue steadily forward.

When it comes to net migration, Canada subsidizes it’s population which has a reproductive rate of 1.2 children per couple with immigrants. Most cities in Canada have immigrants from all over the world moving in and this creates a positive demand for real estate.

Lastly, when it comes to transportation, Canada has several major airports, ship ports, highways, railroads and several ways to transport into the major cities. As a traveler who has travelled to all major Canadian airports I can say that almost all airports I travel to are expanding and upgrading to meet the demand of transportation. In the case of Winnipeg where I live, we are building Centerport which is a second airport just for goods and distribution.

Canada has strong fundamentals, it’s true, when you look at fundamentals, it seems like we are invincible and there can never be a bubble.

Factor #3 – The Financial System

The financial system is the biggest threat to Canadian Real estate when you look at the world banking system, how money is created, distributed and printed.

We are “sleeping with the elephant” in Canada and when the Elephant (the USA) moves, we have to move to.

At the time of writing, the United States is in $20,000,000,000,000 (twenty trillion dollars) in debt. This is a meaningless amount of money and no one knows what will happen with this debt.

The United States currently has a GDP of $18.47 Trillion dollars (source: Google) and they have recently surpassed their GDP with debt. What happens when the debt gets out of control?

Typically governments do NOT pay off their debts and instead, print their way out of debt by diluting the currency until it becomes meaningless. The government prints money and gets to use it first at full purchasing power and by the time you and I get to use the money, it’s worthless.

In 1999 I remember buying lunch for $5, today in Canada lunch is $20, such is inflation.

We need to look at points in history of hyper-inflation where the government tried to print it’s way out of it’s debts and see what happened.

In the 1930’s Germany entered hyperinflation and solved it’s problems by starting World War II

The United States lifted it’s way out of a depression with World War II as well.

Right now in Venezuela hyperinflation is setting in a and civil unrest is taking over: rioting, looting, violence, fires, no food, no hospitals, no medicine, chaos.

We could potentially see a currency collapse of the US dollar.

If the US has to hyper inflate, we have to hyper inflate.

If the US has a currency collapse, who knows the chaos that will ensue.

There are many unknowns when it comes to the world’s superpower and they certainly will affect Canadian Real estate, Canadian central banks and Canadian banks, but who knows how? The world reserve currency, The USD has never been in this position before.

In 2008, the real estate crash happened because the banks failed and suddenly no one could get a loan. No loans means no real estate purchases. No purchases = dropped prices.

Could this happen in Canada? Potentially.

Factor #4 – Demographics

The two biggest demographics in North America are the Baby Boomers and the Echo Boomers (the Millenials).

There will be a major disparity between the wealth of the Baby Boomers and the wealth of the Millenials.

The boomers enjoyed the best economic times of history, they saw amazing returns on their real estate, their stocks, everything went up, up, up. They also got to ride the wave of the best economic times for North America, which is a real bonus.

When a boomer says to a millennial “You are 30, why don’t you have a job and still live at home?” they are thinking of another time in the 70’s and 80’s where $30,000 or $40,000 salary could buy you a house, a car, and a great lifestyle.

In 1968 an ounce of gold was roughly $35. Today an ounce of gold is $1057.10, but wages are still set at the same levels.

In the 1990’s in Winnipeg you could buy a nice house for $50,000 a really nice house for $100,000. Today those same houses are $450,000 and $550,000 or even $750,000.

Wages and salaries are still at $30,000 and $40,000 though and require a degree which makes the millennials have a major problem with being able to buy the lifestyle their parents had.

Indexed to gold, minimum wage in 1968, a job that required no training, education or university was $88,000 of today’s purchasing power. You could get a job at McDonalds and make it in the baby boomer’s economy. In the millennial’s economy, you have to be a super genius or a tech entrepreneur to make it. At the very least, you need to be an engineer to make $88,000 a year which is minimum wage in 1968.

So what does this have to do with Canadian Real Estate and the proposed bubble?

1) When the boomers want to downsize, the largest group of property owners, how are they going to sell for full price to the younger millennials? Answer, the millennials are relatively poor and can’t afford property in the same way their parents can. This creates a problem and asset prices might come down.

2) When the boomers are forced by government law to sell their RRSP’s, 401K’s and other equities when they turn 70, who is in line to buy these investments? The millennials? They don’t have any money! When the government forces the systematic liquidation of RRSP’s and 401K’s we are going to see a major crash in the marketplace starting in 2016 as the first year of baby boomers turn 70.

Factor #5 – International Volatility

This is a major contributing factor to why I think we could see a bubble pop in Canada. As I type this, Donald Trump is threatening North Korea with nuclear war.

Is Trump for real? Or is it just talk?

North Korea is not a real threat, but is this another Afghanistan or Iraq?

Venezuela is falling apart as I type this.

If we do have some sort of global event, World War III? Who knows, that will be a major factor in Canada’s economy:

Canada’s trade will change
Canada’s immigrants may stop coming
Foreign investors will stop coming

You may think that war is out of the question, but every 25 years we have a major war, and when you look at the cycle, the Gulf War was the last major war in 1990, so we are over due for a conflict in 2015. Again this is caused by the USA, we need to watch them and see what happens, but we could easily wake up to a new world in an instant depending on what happens on the international stage.

Factor #6 – X Factor, unforeseen circumstances

The X factor… Mike Tyson, the undisputed heavy weight champion of the world in boxing says “everyone has a plan until he gets punched in the face”.

What happens if hyper inflation happens and oil goes to $1000 a barrel and we can’t get food into grocery stores anymore?

What happens if interest rates spike to 20% because of some international event? It’s happened before in history.

What happens if international trade has to stop for a period of time?

What happens if immigrants are not allowed in the country anymore, or international investors?

The world is in a fragile place right now and you may say “those things will never happen” but they have happened before in history. Some have happened in Canada, and others in countries where the currency collapses.

I’m not here to preach doom and gloom, but I think it’s time to be careful with Canadian Real Estate and keep your eyes open.

The bottom line, the TLDR version (too long didn’t read):

Is there a bubble in Canada?

My answer: Canadian Real Estate is trading above its intrinsic value, the USA is volatile, the world is volatile and you need to be cautious.

My advice to you: Sell any Canadian Real Estate you don’t want, keep the properties you do want with the strongest fundamentals and get as liquid as possible because things may go on sale.

Canada isn’t a green light right now, it’s not a red light, it’s a yellow light. Proceed with caution.

Respect The Grind,
Stefan Aarnio