The Credit Cycle- What it is and How it Impacts Canadian Real Estate

After meeting with Realtors, investors, developers, and economists on a near daily basis it has come to my attention that while some may have a slight understanding of credit cycles, most truly do not understand them. The credit cycle has been my main thesis in these videos so I hope this will explain things further.

Billionaire Hedge Fund Manger Ray Dalio recently published a free book on credit cycles and debt crises. I Highly recommend you download it here

However, here’s a brief summary:

Lending naturally creates self-reinforcing upward movements that eventually reverse to create self-reinforcing downward movements. During the upswings, lending supports spending and investment, which in turn supports incomes and asset prices; increased incomes and asset prices support further borrowing and spending on goods and financial assets. The borrowing essentially lifts spending and incomes above the consistent productivity growth of the economy. Near the peak of the upward cycle, lending is based on the expectation that the above-trend growth will continue indefinitely. But, of course, that can’t happen; eventually income will fall below the cost of the loans.

When money and credit growth are curtailed and/or higher lending standards are imposed, the rates of credit growth and spending slow and more debt service problems emerge. At this point, the top of the upward phase of the debt cycle is at hand. Realizing that credit growth is dangerously fast, the central banks tighten monetary policy to contain it, which often accelerates the decline (though it would have happened anyway, just a bit later). In either case, when the costs of debt service become greater than the amount that can be borrowed to finance spending, the upward cycle reverses. Not only does new lending slow down, but the pressure on debtors to make their payments is increased. The clearer it becomes that debtors are struggling, the less new lending there is. The slowdown in spending and investment that results slows down income growth even further, and asset prices decline.

Economies whose growth is significantly supported by debt-financed building of fixed investments, real estate, and infrastructure are particularly susceptible to large cyclical swings because the fast rates of building those long-lived assets are not sustainable. If you need better housing and you build it, the incremental need to build more housing naturally declines. As spending on housing slows down, so does housing’s impact on growth. Let’s say you have been spending $10 million a year to build an office building (hiring workers, buying steel and concrete, etc.). When the building is finished, the spending will fall to $0 per year, as will the demand for workers and construction materials. From that point forward, growth, income, and the ability to service debt will depend on other demand.

Typically debt crises occur because debt and debt service costs rise faster than the incomes that are needed to service them, causing a deleveraging. While the central bank can alleviate typical debt crises by lowering real and nominal interest rates, severe debt crises (i.e., depressions) occur when this is no longer possible.

19 thoughts on “The Credit Cycle- What it is and How it Impacts Canadian Real Estate”

  1. good video. owners are deleveraging every month so there must be point out there in 5 years or so where the numbers will start a new cycle I guess….certainly the present trend in demographics does look favorable. I m not very good at seeing the future outside next week though.

  2. Something important to remember when using a housing starts graph is the variation (growth) in population size relative to overall starts, and the percentage of each different housing type recorded as a “start”. Additionally, a “new” housing start that replaces a bulldozed legacy house adds complexity to the measurement of actual supply.

  3. in October BC legalizes weed, weed prices just tanked, it's no longer profitable to grow. all these extra homes for growing will need to b sold just adding to the supply, marijuana is a 6billion$+ industry here in BC. dont discount this, y isn't anyone talking about this?

  4. With 43,000 housing units under construction, and the possibility of 4 or 5 interest rate hikes before those units are completed, I wonder how many pre-sale buyers will have to walk away from their deposits.

  5. I have a few thoughts:

    1. Your graphics are slightly off in this video. They show up too early.

    2. I don't think Vancouver's population growth will really slow down if there is a housing and/or economic downturn. There is a huge backlog of immigrants who want to come to Canada and this will continue regardless of economic conditions. For example if Canada decided that they wanted to accept 400K immigrants in a year, they would get 400K immigrants regardless of economic conditions. A large percentage of these immigrants would choose to live in Vancouver for lifestyle reasons such as nice weather, and a diverse/accepting local population even if Vancouver is in a recession. Interprovincial migration makes up a very small percentage of Vancouver's population growth.

  6. You’ve mentioned the RE expansion cycle was up for 10 years. Longest in history. From what I recall the RE boom began around 2002. It went on a run until 2009(US Financial Crisis), took a 6 months correction, came back up and level off sideways(some condos down, houses stabled) until 2012 and started slowly its most current expansion cycle up until this years OFSI Stress Test. I don’t see where your 10 year up cycle period.

  7. Another indicator that popped up this week was an inversion of the 10s30s on Thursday. This looks like it's sticking too this time finally, as the inversion gets deeper and deeper. Perfect indicator of last 2 recessions in Canada at least

  8. Another pertinent subject Steve! Globalization is making our credit cycles longer, and the credit bubbles much bigger. We should expect larger credit corrections in the stock and housing market than many countries have experienced before. I'm extremely concerned about Canada's economy post-correction. We already have major demographic issues we'll face with the boomer generation retiring, and if our economy tanks, immigration will crash and unemployment will inevitably shoot up as well.

  9. Thanks again, Steve; very informative!

    Again I'd like to extend an invitation to your viewers to join in the discussions on my "Metro Vancouver Housing Collapse" Facebook site along with the other 3,430 members who have also joined since last November.

  10. Who knows how far housing could fall in Canada. The way I see it, Canada rode shotgun with the US on their housing boom from roughly 2000-2007 and then in 2007 instead of letting the market correct Gov't of Canada and the BOC stepped in and recreated the bubble ( 0 down 40 year amortizations and 1% overnight rate) then we had the commodity boom from 2010-2013, then finally when housing was about to slow down in 2015 the BOC stepped in again with .5% interest rates. Now here we are in 2018 and the Gov't of Canada is increasing immigration as much as possible. One last desperate attempt to keep the bubble economy going by having new people take out loans. It will be interesting to watch what happens in the years ahead.

  11. I think you have two charts mixed up. You were talking about population growth in Arizona but it showed the chart of units under construction in Vancouver. Great video though!

  12. You get better every week. Three obscure observations. The US ended alcohol prohibition on the 5th of December 1933, at the very bottom of the Great Depression. The US is now moving towards ending prohibition against marijuana. Coincidence? I think not. Secondly, a few commentators have noted similarities to 1937, in how interest rates went up as they are doing now, and that there were US economic sanctions against Japan. A lot of people died a few years later. Third, for decades Robert Prechter has called for a Dow of 6000, S&P of 600, or less. Sounds highly improbable, but Sean Connery's last stint as James Bond was called "Never Say Never Again", at his wife's suggestion. The crash of 2008-9 was never supposed to happen, due to the magic of Greenspan. As you said, things rhyme.

  13. I just watched a you tube video of Ray Dalio talking about his new book ‘Big Debt Crises’ and the situation is frightful!

  14. I generally don't like listening to real estate agents and I usually don't sit through 18 minute videos. But I love your content, great job! You have a great grasp of economics, kudos dude.

  15. Steve, although you use right understanding of credit cycle and use that understanding to make false forecasts, there is one big thing that you do completely wrong.
    That thing is talking about new housing starts decease as a bearish thing. Your reasons are clear: less new construction=less jobs related to RE.
    But in fact, from real estate investing perspective, its completely opposite.

    Housing starts have been completely inadequate for a long time in Vancouver and Toronto. Government attacked investors in new construction, even forced them to pay HST etc.
    And what happens when housing starts decline? No, its not deflating the economy. It is actually creating that big lack of supply and worsening it for future years.
    No immigration is possible without large housing starts numbers. No relief in affordability is possible. No competition on rental market from landlords is possible. Nothing.

    Therefore, housing starts decreasing is a bullish event every time that leads to a bigger supply shortage.
    The housing starts declining in most cases caused not by the bubble fact, but the fact that government did not create enough incentives for real estate investors to put their money into new construction. Indeed, NDP is not very friendly to RE investors.

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