Canada Losing Debt Halo as Property Peaks Under Carney

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Toronto's skyline looms behind new construction in the West Don Lands, a community that's rising in a former industrial zone. Part of the development will house athletes during the 2015 Pan/Parapan American Games. Close

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Photographer: Andrew Moore/Bloomberg Markets

Toronto's skyline looms behind new construction in the West Don Lands, a community that's rising in a former industrial zone. Part of the development will house athletes during the 2015 Pan/Parapan American Games.

Herbert Crockett called Cairo, Geneva and New Delhi home in his four decades as a human resources executive with the World Health Organization. The Prince Edward Island native invested closer to his roots in 2005.

With Toronto on the verge of what turned into a colossal building spree, the 75-year-old retiree bought a C$904,000 ($878,000) one-bedroom suite in the Trump International Hotel & Tower. Eight years later, the 65-story skyscraper is complete, exuding Manhattan-style glamour.

For Crockett, fellow investors and Canadians alike, the glow is fading as home sales tumble, Bloomberg Markets magazine will report in its April issue. They say they’re worried that Canada’s debt-fueled expansion will stall before a global recovery can revive exports -- a slowdown that would blemish Bank of Canada Governor Mark Carney’s record just as he begins his new job as head of the Bank of England on July 1.

More from the April 2013 issue of Bloomberg Markets:

“If the city is any indication of what’s going on in the country, it’s over-reliant on its housing sector,” Crockett says, pointing out a window of a downtown coffee shop to dozens of cranes swinging across the skyline. “I’m afraid of a condo crash, and then what will happen to all the investments?”

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Herbert Crockett, a retired World Health Organization executive who lives in France, invested in a Toronto hotel suite. He says he worries about a condominium crash. Close

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Photographer: Emmanuel Fradin/Bloomberg Markets

Herbert Crockett, a retired World Health Organization executive who lives in France, invested in a Toronto hotel suite. He says he worries about a condominium crash.

Toronto is awash in real estate. There were 144 skyscrapers under construction in late February, more than in any other city in the world, according to SkyscraperPage.com. Proposals for new condos reached 253,768 units at the end of the fourth quarter, up 10 percent from a year earlier, Toronto-based research firm Urbanation Inc. says. Four luxury hotels, each featuring condos, have opened in the past two years.

Gehry Towers

The projects keep coming. Frank Gehry, architect of the landmark Guggenheim Museum Bilbao in Spain, plans three towers. The highest, at 85 floors, would be North America’s tallest residential building.

Crockett, who lives in Crozet, France, says he’s losing C$7,000 a month amid the glut. He says his Trump suite, which guests rent through the hotel reservation system, is occupied about a quarter of the time. He’s suing Donald Trump and the developers for C$2.9 million for misrepresenting investment returns. About two dozen other buyers have brought similar cases.

Crockett says in his lawsuit that a presentation by developer Talon International Development Inc., referred to in court documents, put returns as high as 27 percent a year and that the company wasn’t transparent about room fees and mortgage financing. Crockett adds that after he bought the suite, Talon declined to answer questions about his investment.

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Economy Stalling

Val Levitan, chief executive officer of closely held Talon, denies the allegations, dismissing them as buyer’s remorse. He says sales documents outline risks to investing in a hotel suite. Alan Garten, personal legal counsel for New York-based Trump Organization Inc., says Donald Trump wasn’t involved in selling the properties, calling the allegations “completely without merit.”

The weakening property market is just one sign that Canada’s economy, which everyone from International Monetary Fund Managing Director Christine Lagarde to Carney himself has touted as a model of stability, is stalling.

As recently as September, the World Economic Forum ranked Canada’s banking system the world’s soundest for the fifth straight year. Canada’s bank stocks never fell as far as their U.S. counterparts during the financial crisis, with the Standard & Poor’s/TSX Composite Commercial Banks Industry Index (STCBNK) first surpassing its 2007 high in early 2011 and setting a record on Feb. 20 this year.

‘The Best’

Such performances likely helped Carney, 47, land his new post. British Chancellor of the Exchequer George Osborne called him “quite simply the best, most-experienced and most-qualified person in the world to do the job” in the surprise Nov. 26 announcement.

Now, as the former Goldman Sachs Group Inc. banker prepares to cross the Atlantic, Canada’s households are burdened with record debt, and third-quarter growth, at 0.6 percent, was the lowest in a year. Canada is scheduled to report fourth-quarter gross domestic product on Friday, with economists surveyed by Bloomberg News forecasting no change in growth. Moody’s Investors Service weighed in on Jan. 28. It downgraded six banks the WEF had lauded, saying debt and soaring home prices have left Canadians vulnerable to more bad news.

While Canada may get stellar marks for navigating the global credit crisis, it did so with a borrowing binge, says Benjamin Tal, deputy chief economist at the investment-banking unit of Canadian Imperial Bank of Commerce.

‘Payback Time’

“We basically borrowed our way out of this recession,” Tal says. “Now, it’s payback time. We will be in for a period of long, slow growth.”

Canada’s property blitz is winding down just as U.S. housing perks up. Construction of new Canadian homes plunged 19 percent in January from December to the lowest number since the end of 2009; sales of existing homes fell 8.8 percent from a year earlier. Toronto suffered a 36 percent decline in new condo sales in 2012 from 2011; resales dropped 10 percent, the first annual decline since 2008, Urbanation says.

Home prices are for the most part still rising on average in big cities -- except in Vancouver, where they fell 8 percent from their peak in May 2011 through January. In contrast, sales of new and previously owned U.S. properties rose 9.9 percent last year, the biggest annual gain since 1998.

Mortgage Changes

Hoda Seraji is experiencing Vancouver’s housing slowdown firsthand. A real estate agent, she took her own family’s two- story house in Canada’s third-largest city off the market after failing to get a single bite for the C$2.39 million home overlooking the Pacific. Cutting the price for the five-bedroom, four-bathroom residence didn’t help.

“Buyers are very skeptical, very hesitant because they think prices may go down,” she says.

Seraji blames fading interest from foreign investors, especially in China. Changes to Canada’s mortgage rules designed to cool the market have accelerated the sales drop, she says.

Finance Minister Jim Flaherty announced new regulations on home loans for the fourth time in four years in June, reducing the maximum amortization period on mortgages the government insures to 25 years from 30 years. It had been as high as 40 years in 2008.

Both Flaherty and Carney have campaigned against the perils of household debt, with Carney warning in June 2011 that valuations in some markets were reaching “severely unaffordable” levels.

Taxpayer Liability

Until the government’s latest tightening, however, Canadians weren’t listening. Carney slashed benchmark interest rates more than four percentage points to 0.25 percent during the recession, pushing five-year mortgage rates to less than 3 percent. That helped Canadians enjoy the lowest borrowing costs in the Group of 20 nations outside Europe, Japan and the U.S. Flaherty increased the stimulus with guarantees and tax credits for homeowners.

Encouraged by cheap money, Canadians couldn’t resist the housing market. The average price of homes sold jumped 82 percent during the 10 years through January, rising more than 30 percent from January 2009 alone, according to the Canadian Real Estate Association.

The value of mortgages insured by the government’s housing agency swelled 98 percent to $575.8 billion at the end of September from the end of 2006, foisting a growing liability onto taxpayers. Meantime, Canadians became more indebted than Americans in 2011. The ratio of household debt to disposable income has continued to rise, hitting a record 165 percent in the third quarter of 2012, according to Statistics Canada.

Official Hectoring

The mixed message of borrow but save isn’t lost on economists.

“It did seem a little unusual to have every policy maker in Ottawa hectoring Canadians about their excessive debt levels and yet the economic incentive for the average Canadian was completely slanted to taking on debt and not saving,” says Douglas Porter, chief economist at Bank of Montreal.

“The realist in me would admit it was the only tool the Bank of Canada had. The reality was, they really could not lift interest rates.”

With global rates so low, any independent increase would set off a surge in the Canadian dollar. Carney dampened expectations for higher borrowing costs at the end of January, saying rate increases were “less imminent” because of weaker- than-anticipated business investment and exports. He’ll be more than 18 months into his new job before his successor, who has yet to be named, raises borrowing costs again, some economists predict.

Exports Struggle

There’s little evidence exports will help Canada offset any drag from its housing-sparked debt addiction. In the third quarter, outbound shipments, including oil, plunged 7.8 percent from the second quarter and had dropped 8 percentage points to 30 percent of GDP since 2000.

Meantime, the share of GDP linked to housing, including construction and renovation, soared to more than 20 percent. A similar U.S. measure peaked at 18 percent in 2005. Canada’s share of construction jobs in total employment was 7.3 percent in January, above the 4.3 percent in the U.S.

“This heavy reliance is not healthy,” CIBC’s Tal says. “I expect to see some softening.”

Many of Canada’s construction workers have been toiling on Toronto’s condos. Lou Rivera wonders who will live in them. Rivera, 55, found out in November that property owner Mondelez Canada Inc., a unit of Mondelez International Inc. (MDLZ) will close this year the Mr. Christie’s bakery where he has worked as a production mechanic for 14 years and sell the land. The factory, which employs 550 people to pump out animal crackers and other snacks, may be replaced with 27 condo towers, documents filed with the city’s planning board say.

‘Big Correction’

“What will happen, 550 people will be jobless,” Rivera says in the plant’s snow-covered parking lot, which already is hemmed in by new condo developments named Eau du Soleil and Ocean Club. “Will they work at the condos? No. Will they live in them? No.”

Steve Hennessey, a sales representative for Right at Home Realty Inc., Canada’s largest independent real estate brokerage, predicts Toronto home prices will tumble 20 percent during the next two years.

“We’re due for a big correction,” he says.

David Rosenberg, chief economist and strategist at Gluskin Sheff & Associates Inc. in Toronto, wonders what would trigger a slump. He expects rates to stay low.

Missing Ingredients

“I don’t think the Bank of Canada is going to have a smoking gun to raise interest rates,” says Rosenberg, who, as chief economist for North America at Merrill Lynch & Co. in New York from 2002 to 2009, was among the first economists to predict a U.S. housing collapse.

Canada is also missing ingredients that made the U.S. market so toxic -- subprime borrowers and banks that lent with little diligence. With about 62 percent of mortgages issued by Canadian banks insured by the federal government, the nation’s six big banks are more sheltered from delinquencies than American counterparts.

What may push Canadian housing over the edge, however, is another slowdown in the global economy. This could further weigh on exports and jobs, prompting the country’s maxed-out consumers to cool their love affair with real estate.

“As an economist working for a Canadian bank, I can’t go into a client meeting and have someone not ask me about housing in Canada,” says Tom Porcelli, chief U.S. economist at RBC Capital Markets LLC, Royal Bank of Canada’s investment-banking unit, in New York. “For U.S. investors, they are still a little gun-shy about what happened in the U.S., and I think they worry the same fate will happen to Canada.”

Timely Escape

While Crockett’s case against the Trump hotel’s developers winds through the courts and the once-hot housing market sputters, Carney will be facing new hurdles at the Bank of England. Jens Larsen, chief European economist at RBC Capital Markets in London, says Carney is likely to come up short.

“He had tremendous press, and it was a huge coup for the chancellor to be able to land him,” Larsen says. “You look at the expectations, and you look at the challenge he has in front of him, and some disappointment is likely.”

There are already signs of how difficult Carney’s job may be. Because Britain’s economy shrank in the fourth quarter, he could find himself struggling with fallout from an unprecedented triple-dip recession. Yet, if Canada’s home sales keep sliding and household debt keeps rising, the banker who helped orchestrate his nation’s vaunted growth and stability may consider his trans-Atlantic move a timely escape.

To contact the reporters on this story: Jacqueline Thorpe in Toronto at jthorpe23@bloomberg.net; Theophilos Argitis in Ottawa at targitis@bloomberg.net; Katia Dmitrieva in Toronto at edmitrieva1@bloomberg.net

To contact the editor responsible for this story: David Scanlan at dscanlan@bloomberg.net

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