Summary:

In the worst-case scenario, house prices may crash about 25 percent, in real terms, in a recession.

The Impact of a recession on house prices, in real terms, can confidently be expected to be -6% ± 18%.

The report includes value at risk (VaR) analysis, and different scenarios and their impact on house prices in Canada, for definitive answers.

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Every new buyer and homeowner has this concern. . . how much can the house prices crash in a recession in Canada? With the memories of the 2008 financial crisis still vivid in our minds, combined with the pessimism that 2020 carried with the pandemic, people have naturally developed 'anxiousness' regarding all aspects of their financial health.

Alternatively, national and international investors with real estate holdings as part of their portfolio also have this concern. If the economy's recessionary condition persists, or if there is another lagging-conditional recession in the next 4-6 years (which, of course, is likely), how much can house prices crash in Canada? An accurate assessment can be a critical aid in devising hedging strategies and formulating remedial actions.

Many 'gurus' give predictions regarding what can happen; however, any 'assessment' that is not based on data and modeling is . . . well . . . worthless. This report utilizes 4 decades of data to understand this issue with precision for definitive answers.

'Nominal house prices data,' from the Organization for Economic Co-operation and Development (OECD), is used in this report for an in-depth examination. All data and calculations are available at the end of the report.

The final derived value of the analysis is also adjusted for the per-period inflation rate to derive the real value, i.e., the Impact of the recession, in real terms, in addition to the nominal Impact.

### So, what does the data reveal?

Examination of the last 4 recessions (1981-2020) reveals that, on average, the recession impacts house prices by -6.01 percent (adjusted for the rate of inflation per recessionary period (Link)), and the nominal price of homes decreased by -1.41 percent. Furthermore, other than the 2020 distress period, housing prices were negatively impacted in all other recessions in the data set.

What about future recessions? How much can we expect house prices to crash/decline in the next recession? Confidence interval for the mean Impact of recessions has been calculated to examine how future recessions may impact house prices

(real Impact):

Mean confidence interval: [-24.2% , 12%] Alternatively: -6% ± 18%

Since the population's σ is not known, the formula uses the T distribution with n-1 degrees of freedom: X ± T(1-α/2)(df)S/√n.

-0.061037905 ± T(1-0.020/2)(3)⋅0.079792105/√4

(nominal Impact): Mean confidence interval: [-11.7%, 9%] Alternatively: -1.4% ± 10.30%

Since the population's σ is not known, the formula uses the T distribution with n-1 degrees of freedom:

X ± T(1-α/2)(df)S/√n.

-0.014062905 ± T(1-0.020/2)(3)⋅0.045383563/√4

If you calculated the confidence interval over an infinite number of samples with a sample size of 4, 98% of the calculated confidence intervals will contain the mean's true value.

Simplistically, this means that the worst-case scenario, as per the data, is a -24.2% real decline, or a -11.7% nominal decline in house prices in a recession; the best-case scenario is a 12% real appreciation or a 9% nominal appreciation; as per the data of the last 4 recessionary periods.

We can state with 98% confidence that the next recession's actual impact, as per the examination of previous 4 recessions, is likely to be -24.2% to 12% in real terms, adjusted for the long-term inflation rate or -11.71% to 9% in nominal terms.

The real figure is more important to remember in this scenario; this, simplistically, means that in a recession, for every $100,000 in equity in a house, as per the data of last 4 recessions, a homeowner or investor is at risk of losing a real value of $24,200, in the worst-case.

### So, how much money am I risking by buying a new home or holding property? How much can the price of a house decline in Canada, after you buy, especially in a recession?

A value at risk (VaR) analysis that measures how an asset's value is likely to decrease in a specific period is implemented for definitive answers. Using a 95% confidence interval, the VaR is calculated as: z = (x-µ)/σ

X= (-1.65 × 8) + 100 = 86.8.

Simplistically, this means that for every $100,000 in equity in a house, we can state with 95% confidence, as per our assessment of the past 4 recessionary periods, that the losses should not exceed $13,200 or 13.2%; The upper limit of losses, in the worst-case scenario, should be around 24.2% (as explained in the previous paragraph). Thus, we can say, confidently, that in a recession, the worst-case an investor, homeowner, or buyer should prepare for is maximum losses of -25%, or $25,000 per every $100,000 of real estate value.

Nonetheless, it should be noted that these are the most likely values, and, of course, there is always a possibility of a one-off idiosyncratic event being much worse. It is also important to note that this analysis encompasses recessionary decline only, and fluctuations of the property market, which are not related to recessionary periods are not included in this examination.

However, in terms of recessionary decline, it is safe to say that losses greater than -25 percent, as per the analysis of the previous 4 recessions, are unlikely.

We cannot, and should not, make decisions based on 'anomalous happenings,' as there are infinite strange, aberrant events that can happen for better or for worse. A hedging or risk-mitigating strategy that equips an investor or homeowner with an appropriate response to handle a worst-case scenario of -25% decline in property prices should suffice.

### How does a recession impact homeowners' wealth? Does a recession impact homeowners' wealth in Canada?

Each recessionary period in Canada, on average, can devalue a property by -6.1% in real terms, and this means about -$6,100 decline per 100,000. In nominal terms, the decline can be around -1.41%; this means a -$1,410 reduction in value per $100,000. The more recessionary periods the economy suffers, the lower the long-term growth rate of price appreciation.

For an average house price, of about $670,000, for example, a recessionary period would decline its value to $629,130 in real-term; in the worst-case, the real value can decrease to about $507,900, of course, a very substantial decline of $162,100, per average house price of $670,000.

In other words, in a recession, an average house, in the worst-case scenario in Canada, can cost an average income earning Canadian 3 years of salary in losses. In the base-case scenario, in a recession, the losses are likely to be about 1-year of average Canadian salary, per an average priced house.

These are very substantial figures that should alert all intelligent investors. For a portfolio of properties, this figure can amount to very damaging losses. Risk mitigation and strategizing are therefore of utmost importance. (See below for formulating hedging strategies)

As more recessionary periods are experienced, more value is eroded from long-term appreciation of a house, and the long-term growth, depending on the severity of the recession, can substantially decline an individual or investors wealth, as explained above (of course, proper hedging strategies would prevent the erosion of wealth).

For investment properties, it therefore makes more sense to explore hedging strategies, or the possibility of liquidating the property portfolio as leading economic indicators signal a cyclical turn in the business cycle; this is especially important in the late stages of the business cycle. Analysis reveals that during a 50-year holding period, constant severe recessions can deteriorate the value of the property by 75% in the long run, compared to no severe recessions during a holding period (see report for further understanding: How much do house prices fall, or crash, in a recession: 40 years of data analyzed.)

Every homeowner or investor should carefully understand and examine the risks before buying a new property or holding the existing property portfolio. It should also be noted that as concerns regarding a property bubble build, there is also a possibility of an idiosyncratic crash in the property prices. Nonetheless, those that have a solid risk-mitigation strategy for a possible -25% decline in property prices should weather the storm better than those that do not. Devising a risk mitigation strategy is also crucial as concerns of a price bubble bursting increase, day by day.

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Data and Calculations:

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