In the prior update, we flagged that early signs of deterioration in the Toronto housing market are causing an ever-so-gradual price decline in Canadian bank equity prices. The share prices have rebounded by a few percent since then. However, after a bit of gumshoe investigating – primarily calling our contacts the GTA real estate agency and mortgage businesses – we see some substance to the concerns.

 

Industry data on home prices is lagged; on a more real-time (but also anecdotal) basis, our contacts estimate that detached-home prices in Toronto have fallen 15-20% over the past 60 days. Buyers in the high-end market appear to be adopting a “let’s wait and see how ugly it gets” attitude, while for average-priced homes buyers now have less to spend as mortgage rates have now risen following the regulatory change in April. On the other hand, the GTA condo market so far appears unaffected.

 

In isolation, this should have no real impact on Canadian bank share prices. A 20% drop would only move Toronto home prices back to last year’s levels, and half of the banks’ mortgage loan books are CMHC insured anyway. Importantly too, the drop in housing prices has not been catalyzed by rising mortgage delinquencies, as was the case a decade ago in the US.

 

But to the extent that the price drop eventually reduces the very meaningful amount of new condo construction and residential redevelopment work going on in the Toronto-area, it will absolutely dampen Canadian economic growth. A slowdown of that nature would moderately affect the other 55% of the banks’ loan books. Maybe more importantly for share prices, there remains a strong desire in the equity markets to identify the next "Big Short" – if Canadian banks rightly or wrongly become the target of that, their share prices are going to meaningfully overshoot. From our perspective - which is purely investment-oriented - we would welcome such an event as an opportunitic moment to gain equity exposure to the sector.