Is Canadian Real Estate a Ticking Time Bomb?

An analyst has predicted Canada’s real estate market is headed 30% lower. What does this mean for investors?

| More on:
The Motley Fool

You’re reading a free article with opinions that may differ from The Motley Fool’s premium investing services. Become a Motley Fool member today to get instant access to our top analyst recommendations, in-depth research, investing resources, and more. Learn More

Last week, a report written by equity researcher Dan Werner of Morningstar warned that the Canadian real estate market is seriously overvalued. Because of a multitude of factors, Werner went as far as predicting that Canada could see a 30% nationwide decline in the price of houses.

Werner had several reasons for predicting such doom and gloom. Canadian law states that all mortgages (except in Alberta) are recourse loans. In theory, this would insulate lenders from large-scale defaults, since borrowers can be sued for any shortfall. But in reality, some of the hardest hit states in the U.S. housing meltdown were recourse states. When a borrower has most of their net worth tied up in housing, there’s little reason to sue for the scraps that remain.

Canadian debt-to-equity ratios look awfully similar to U.S. numbers at the top of its market, as 23% of Canadian homeowners have a debt-to-value ratio of greater than 80%. The number in the U.S. at its peak was 22%. Sure, the average homeowner owns about 55% of their home, but that’s weighed down considerably by the millions of Canadians who own their homes outright.

Werner also cites evidence that many Canadian borrowers can’t handle higher interest rates. More than 2.5 million of us have used our RRSP to help out with funding the down payment. This loan must be repaid over time, or else the recipient has to pay tax on the proceeds. In recent years, a full 25% of Canadians couldn’t afford to pay their RRSP loans back.

So if a crash happens, what does it mean for investors?

It’s obviously bad news for a company like Home Capital Group (TSX: HGC), which lends money to folks who don’t qualify at a traditional lender.

The company has been reporting some great results. Its most recent loan losses came in at less than 0.1% of its portfolio, and it continues to grow its business nicely. Management has done a terrific job leveraging mortgage brokers to help grow the business without the added cost of having to open up physical locations. The company has become Canada’s leading alternative lender.

This is all fine and dandy when the housing market continues to hit new highs. But what happens if it starts to decline in a significant way? The answer is pretty clear.

The share price will go down.

It doesn’t matter if the company has rock solid fundamentals. Investors will see the real estate market start to decline and flee for the exits. Investor sentiment is important for most companies, but it’s doubly important for Home Capital.

Canada’s largest lenders will also suffer in the event of a housing correction. The vast majority of earnings growth from Royal Bank (TSX: RY)(NYSE: RY) and TD Bank (TSX: TD)(NYSE: TD) has been from increases in mortgage and secured line of credit business. Both these banks are such big lenders that it will be difficult for either of them to make up for any lack of growth in mortgages.

Even if Canada’s real estate market has the proverbial ‘soft landing’ it’s hard to paint a bullish picture on the banks. If mortgage growth dries up, chances are economic growth will also be tepid, since many Canadians are borrowing against their house to consume. It’s one of the reasons why bank stocks are trading at a pretty significant P/E discount compared to the overall market.

For investors who are looking to buy Canadian bank stocks, the question is simple — do you think the value of Canadian homes is about to fall? If you believe Morningstar and think a 30% correction is imminent, you’ll want to stay away from the banks, and definitely stay away from Home Capital.

If you think the market will keep chugging higher, the banks probably represent pretty good value at today’s prices. That’s up to you to decide, but personally I’m staying away.

Should you invest $1,000 in Alimentation Couche-Tard right now?

Before you buy stock in Alimentation Couche-Tard, consider this:

The Motley Fool Stock Advisor Canada analyst team just identified what they believe are the Top Stocks for 2025 and Beyond for investors to buy now… and Alimentation Couche-Tard wasn’t one of them. The Top Stocks that made the cut could potentially produce monster returns in the coming years.

Consider MercadoLibre, which we first recommended on January 8, 2014 ... if you invested $1,000 in the “eBay of Latin America” at the time of our recommendation, you’d have $18,391.46!*

Stock Advisor Canada provides investors with an easy-to-follow blueprint for success, including guidance on building a portfolio, regular updates from analysts, and two new stock picks each month – one from Canada and one from the U.S. The Stock Advisor Canada service has outperformed the return of S&P/TSX Composite Index by 35 percentage points since 2013*.

See the Top Stocks * Returns as of 1/7/25

This article represents the opinion of the writer, who may disagree with the “official” recommendation position of a Motley Fool premium service or advisor. We’re Motley! Questioning an investing thesis — even one of our own — helps us all think critically about investing and make decisions that help us become smarter, happier, and richer, so we sometimes publish articles that may not be in line with recommendations, rankings or other content.

If You Thought Apple and Microsoft Were Big, You Need to Read This.

The steel industry produced the world's first $1 billion company in 1901, and it wasn't until 117 years later that technology giant Apple became the first-ever company to reach a $1 trillion valuation.

But what if I told you artificial intelligence (AI) is about to accelerate the pace of value creation? AI has the potential to produce several trillion-dollar companies in the future, and The Motley Fool is watching one very closely right now.

Don't fumble this potential wealth-building opportunity by navigating it alone. The Motley Fool has a proven track record of picking revolutionary growth stocks early, from Netflix to Amazon, so become a premium member today.

See the 'AI Supercycle' Stock

More on Investing

oil pump jack under night sky
Energy Stocks

Top Energy Sector Stocks to Invest in for 2025

Here are three top Canadian energy sector stocks that look like solid buys in 2025 for those looking to ride…

Read more »

A meter measures energy use.
Energy Stocks

Got $2,500? 3 Utility Stocks to Buy and Hold Forever

These utility stocks are known for their solid earnings and consistent dividend growth, making them compelling investments.

Read more »

dividend growth for passive income
Dividend Stocks

Got $2,500? 4 Insurance Stocks to Buy and Hold Forever

Fairfax Financial Holdings (TSX:FFH) looks like an intriguing buy in 2025.

Read more »

Caution, careful
Investing

Trump Tariffs: 1 TSX Stock That Could Take a Beating

Magna International (TSX:MG) stock looks like it could be at risk should Trump tariffs be on the horizon.

Read more »

tsx today
Stock Market

TSX Today: What to Watch for in Stocks on Tuesday, January 21

Besides the domestic consumer inflation report, TSX investors’ focus will remain on any developments regarding global trade policies under the…

Read more »

how to save money
Tech Stocks

The Smartest Growth Stock to Buy Right Away With $5,000

If you want a growth stock, you want a company that has a stable path forward. So, let's look into…

Read more »

Blocks conceptualizing Canada's Tax Free Savings Account
Dividend Stocks

TFSA: How to Turn the New $7,000 Contribution Into Monthly Passive Income

Wondering how to earn monthly passive income from your recent $7,000 TFSA contribution. Here are two stocks to consider adding…

Read more »

dividends grow over time
Dividend Stocks

These 3 Canadian Stocks Could Triple in 5 Years

These three Canadian stocks are in a prime position for future growth. But some patience may be needed along the…

Read more »