Another Housing Bubble May Be Near

If you thought the U.S. housing market looked bad, you should check out what's happening up north...

You wouldn't be wrong to think U.S. home prices have gotten a lot more expensive recently. They're up 192% in the past 25 years.

But Canada's housing market makes that look like child's play.

Canadian home prices rose 553% in the past two and a half decades. In other words, the average home costs six times more today than in 1997.

This ballooning of the Canadian real estate market reminds us of what happened in the U.S. during the Great Recession.

You see, to afford a home in Canada, many folks acted like prices would only go up... forever. Some families took out second and third mortgages to afford real estate.

Then interest rates started soaring this year. The proverbial shoe looks ready to drop.

Research from the Bank of Montreal shows that almost 20% of the total housing market is financed through variable-rate mortgages. That means the interest rate can change depending on what the credit market does.

People borrowed when mortgage rates were around 1.5%. Since then, the rates have climbed to more than 5%. That has increased mortgage payments by a huge margin.

Canada's economy is heavily dependent on residential investments. The real estate market makes up almost 10% of the country's gross domestic product.

If Canadians can't afford to buy houses, the country's economy could crash...

We can see this through Canadian real estate company Information Services Corporation (ISV.TO). It oversees title registry and information-management services for public data and records in Canada.

In other words, when people need to register new businesses, homes, and other developments, they go to Information Services Corporation.

The company's revenue is based on registration activity. So its performance is linked with the health of Canadian real estate. Investor expectations for the company can tell us a lot about where registration activity – and the sector in general – is headed.

Information Services Corporation has been a phenomenal, stable business for years... and its profitability is on the rise.

Its Uniform return on assets ("ROA") has never been below 40%. It reached an all-time high of 93% last year.

But that alone isn't enough to boost our confidence in Canadian real estate.

Investors seem to realize that registration activity may have peaked...

We can see this through our Embedded Expectations Analysis ("EEA") framework. It uses a company's current stock price and Uniform Accounting data to tell us what the market expects going forward.

Information Services Corporation's EEA shows that investors expect its Uniform ROA to fall to 36%. That would be the lowest level in company history.

Take a look...

Since 2010, Uniform ROA has only dropped below 50% once. But investors expect a significant decline in profitability by 2026. They think title registrations will fall to 13-year lows.

That could be a strong negative signal for Canada's housing market. If registration activity slows down, one of the biggest hits could be to new development.

You might want to stay away from homebuilders while this plays out... both in Canada and the U.S.

Like Canada, the U.S. housing market has had its share of craziness lately. Our homebuilders could be in for similar rough waters as long as interest rates stay high.

Regards,

Rob Spivey
December 7, 2022

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