Canada Housing Bubble Deflating Slowly & Softly ?

Canadian Housing Bubble?

Overvalued Housing Market

By Joseph Cafariello

While the American housing market is recovering from its flu, Canada’s may be showing symptoms of its own.

housing bubbles

The Organization for Economic Co-operation and Development – an international economic forum where 34 member countries compare and consider free market policies and practices – has this week rated Canada’s housing market the third most overvalued in the world, just behind Belgium and Norway.  More alarming still, the organization has put the Canadian housing market on its watch-list as one of those most vulnerable to correct.

It has been 5 years since the American housing market sneezed.  Has Canada finally caught its cold?

State of Canadian Housing

This spring upheld its reputation as Canada’s most active home buying season.  The Teranet-National Bank Composite House Price Index on Wednesday showed average prices of repeat sales of single-family homes in Canada rose 1.1% in May over April, continuing a trend of May surges of 1% or more in 9 of the past 15 years.

OECD housing data comparing annual price changes in 20 economically developed countries from 2005 to 2012 ranks Canada as:

• 3rd highest in 2012 nominal change @ 4.8%, behind Norway’s 6.7% and Germany’s 5.3%

          – U.S. ranks in 6th place @ 3.4%

• 3rd highest in 2012 real change @ 3.6%, behind Norway’s 5.8% and Switzerland’s 4.2%

          – U.S. ranks in 6th place @ 1.6%

• 2nd highest in average nominal change 2005-12 @ 6.59%, behind Norway’s 7.29%

          – U.S. ranks in 19th place @ -0.06%

• 2nd highest in average real change 2005-12 @ 5.06%, behind Norway’s 5.4%

          – U.S. ranks in 19th place @ -2.21%

In an attempt to cool the red hot housing market, the Canadian government in July of 2012 tightened mortgage lending rules and qualification requisites.  Though this did dampen home sales throughout the autumn and winter, this week’s Teranet index showed that rising prices are back, posting yearly increases of 2% in April and May over their prior 12-month readings.

The suspicion that last year’s tighter mortgage qualifications have lost their tranquilizing effect was confirmed by Monday’s Canada Mortgage and Housing Corporation’s report showing a higher than expected jump in new housing starts in May from April.

Only on the West Coast of the country did annual housing prices drop in May, mainly in Vancouver (-3.2%) and Victoria (-4.1%).  Yet this comes after years of leading the nation on the way up.

The remaining 9 major metropolitan regions in the country all saw annual rises in May ranging from the lowest at 1.9% in Montreal to the highest at 6.5% in Quebec City – a mere 155 miles apart!  The nation’s largest city of Toronto ranked right in the middle with an annual May gain of 3.9%. (All data Reuters.)

It’s Not A Bubble

Well now we’re simply redefining words, as officials are reluctant to call Canadian housing a “bubble”.

In an interview with the Wall Street Journal’s Canada Real Time, OECD secretary-general Angel Gurria was keen on making a distinction.  “An overvalued housing market and a bubble are not the same thing,” he addressed.  “The housing market has been building very steadily over a period based on growth, jobs, good income, and a Canadian economy that’s been in good shape. Frankly, it’s not a bubble in the sense of a great big speculation in the property market. I think there will be a cull in some investment in the sector, which will see prices stabilize over time.”

In that, Gurria makes a valid point that can be applied to any market rising in price – be it in housing, equities or commodities.  As long as a populace can afford the higher prices of homes, stocks, and materials through increasing wages and economic prosperity, then you really do not have a bubbling, exaggerated distortion in prices.  All you have in this case is a steadily increasing valuation that is not in danger of popping since the underlying foundation of affordability is rising in good pace with the prices.

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Another reason few in Canada are worried about a collapse in the nation’s housing sector is the state of the country’s banking system.  Where America’s banking and mortgage industries were progressively weakened by risky practices for years leading up to its housing crisis, Canada’s financial sector has remained sound and stable.

“I think that the Canadian economy has managed to navigate a lot better through the crisis, among other things, because its financial system was better regulated and capitalized,” Gurria contrasted.  “Canada also has a very prudent fiscal policy. It had it before the [American] crisis struck, when [Prime Ministers] Chretien and Martin built it over time. I think it’s working well. All together, I’d say that Canada is reaping the rewards of past virtue and also present good practices. It would be good if there were many more countries like that.”

Well, stable banking and mortgage systems built up over decades since the early 1980’s do provide a nice solid support under housing prices… today.  But what about the future?  Is not Canada largely a resource producer?  Is not the global slow down dampening the demand for commodities?  Might Canada’s economy slow the way Australia’s has, which would in turn trigger a drastic downward correction in Canadian housing values?

“One of the big differences between the two countries [Canada vs Australia],” Gurria answers, “is that Canada has a much more diversified economy on the manufacturing side. It’s also next to the biggest economy in the world, which it has a free trade agreement with. Canada also has a very generous endowment of natural resources which have been a big bonanza for the country.”

Stability Most Likely

Thus, while the OECD has put Canada on its watch-list of housing markets most due a correction, its officials do not consider it a bubble in danger of bursting.

Given the diversity of Canada’s economy, it is unlikely that even a major global slow down in commodities will have a recessive impact.  The Canadian dollar has remained stable for several years in a range from slightly under par to slightly over par with the U.S. dollar, providing a nice balance between export value and import power.

Interest rates are also moderately low; not low enough to fuel a hot housing market into a raging inferno, yet not high enough to impede global competitiveness.  Unemployment has fallen from April’s 7.2% to 7.1% in May, with a forecast of 6.7% in 2014.  And economic growth is expected to be a comfortable 1.4% this year and 2.3% the next – just enough to keep pace with the rising housing market.

Housing prices in the western-most Canadian province of British Columbia on the Pacific coast falling for the first time in a long while seems to confirm the government’s ability to keep things from running out of control.

With a reputation for tough regulation and active vigilance, there is every indication that the past 3 decades of stable growth in the Canadian economy and its housing market will continue in a gentle upward slope for decades more.

Joseph Cafariello

Is Canada’s housing market on the verge of a crash?

By Jennifer Kwan

Canada’s housing market has been a wildly popular topic lately with experts sounding off on everything from house-market affordability to house-buying intentions to the effects of too-long, very-low interest rates. All this is keeping the debate about the soft landing, or crash to come, firmly on the minds of Canadians.

The common link is the Bank of Canada’s benchmark rate, which has been frozen at 1.0 per cent since September 2010. The market doesn’t expect the central bank to move higher — if it moves higher — until sometime in the latter part of 2014, or even later, so in some ways there’s a bit more time to sit back, wait and watch.

If you believe The Economist, Canada’s housing market is “especially vulnerable” to a major correction, according to a recent analysis on global property markets. It says house prices here are overvalued by 73 per cent compared to rental prices, and 32 per cent overvalued when compared to household incomes.

“Home sales in March were 15% down on a year earlier. Buyers are in short supply. A recent poll showed that only 15% of Canadians are likely to buy a home in the next two years, down from 27% last year—the steepest decline in the 20-year history of the survey. After a big boom, the housing bust will be a wrenching affair,” the magazine stated earlier this month. This is golden for those who are in the doom and gloom camp, and don’t believe house prices will bounce any time soon.

Now, combine that with a recent warning by the Canadian Association of Accredited Mortgage Professionals. This week the group said many Canadians are managing their debt responsibly, and warned Ottawa’s clampdown on mortgage lending rules has set the stage for up to a 30 per cent plunge in home sales by 2015, translating into massive job losses related to the industry and other negative things that could crimp economic activity. Think of all those first-time home buyers who may be on the sidelines.

But in findings that appear to contradict The Economist and other pessimistic views, an RBC Economics analysis stated that while Canada’s housing market still faces higher-than-usual stress, recent affordability measures don’t suggest a “significant nation-wide price correction is imminent.” In fact, the low mortgage rates helped make owning a house relatively affordable — though arguably a more accurate definition would be less unaffordable —  in the first quarter of 2013, of course, with variations across regions.

At the same time, BMO housing confidence report showed consumers’ buying intentions were bolstered by low interest rates. This poll found some 45 per cent of Canadian homeowners say they are looking to buy a property in the next five years, also with results varying from region to region, in another bit of data to play up the good news story to reassure Canadians the sky isn’t falling. What’s more, it says first-time homebuyers could take advantage of low rates and shorter amortization periods for financial stability.

Given all the data, one can’t help but think everything is being held together — but just barely — thanks to low interest rates.

On that note, consider one final, powerful warning to add to the mix. The head of the country’s banking watchdog told a Bloomberg economic summit this week that a transition to higher rates could be really, really bad. That is, it is a greater incentive for banks to take on more risks when lending, business to depend on cheap credit and for borrowers take on more debt.

“No one can predict when, or how fast, rates will start to climb (or indeed, whether they will fall further),” Julie Dickson said in prepared text of a speech she delivered at the summit. “Yet dependence on low interest rates can become significant, meaning that transition to higher rates could be very painful.”

So is it a soft landing or crash? Even though it’s been many months since Ottawa clamped down on mortgage-lending rules the debate still rages. “This is very unprecedented. Normally when we see a significant drop in sales volumes — and it’s been very significant, it’s been double digits in most markets — when we’ve seen that, following three to six months later we normally see a significant drop in prices. And we haven’t seen that yet,” says John Andrew, a real estate professor at Queen’s University.

It seems likely rates will stay low for a while longer yet so making a move now in the house market is probably a safe bet, on the assumption rates will climb higher that makes number crunching household budgets increasingly crucial. More hints will likely to be dropped next week when the Bank of Canada makes its rate announcement and market experts comb through the central bank’s policy statement for another piece of the puzzle and clearer way forward.

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