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Only 12.9 per cent pre-tax income going to homeownership costs
Apr 07, 2006

Canada’s seven-year long housing market boom has so far generated a 40-per-cent inflation-adjusted cumulative rise in the national average home price, according to the latest Real Estate Trends, released by Scotia Economics. 

While the risk of an eventual correction in housing prices is rising as this cycle ages and borrowing costs continue to edge higher, the likelihood of a sizeable price reversal is still relatively low — there will be no bubble bursting in the housing market.

A new report from TD Bank Financial Group, called Housing Bubble Watch, said this is indeed the case.

Craig Alexander, vice-president and deputy chief economist for TD Bank Financial Group, said there are no warning signs that a bubble has formed in either Manitoba or Saskatchewan.

“After stripping off inflation, real home prices in Winnipeg are rising at  a 9.6-per-cent year-over-year pace, just slightly above their performance a year earlier,” he said.

Alexander said affordability remains high in Winnipeg where only 12.9 per cent of pre-tax income is going to homeownership costs.

“Our irrational exuberance indicator has increased in both (Manitoba and Saskatchewan) markets, but a comparison of the cost of renting compared to homeownership still suggests that real estate markets have not become out of touch with reality.

“So, while home prices cannot continue to rise at their recent pace indefinitely, there is a good chance that when the moderation comes it will not be a major retrenchment ...,” Alexander added. 

“From a historical perspective, the duration of the current upswing in home prices is relatively long,” said Adrienne Warren, senior economist, Scotia Economics. “Over the past 50 years, there have been three other major cycles of rising real home prices in Canada, each lasting from five to six years.

“The magnitude of the current price gain, however, is not out of the ordinary, with the rise in real home prices essentially in line with the average 44 per cent increase recorded over the prior three cycles.”    

Winnipeg Real Estate Board president Walter Boni said there are early signs this year of a robust local housing market with no slowdown in sight.

He said a good sign is that supply is starting to catch up with demand which means a more stable housing market.

According to Scotia Bank, housing valuations in Canada still appear well supported by economic fundamentals. The rise in home prices is being driven by tight supply-demand conditions, not investor speculation. 

“For 2006,” added Boni, “the leading indicators are all very positive. Inflation is under control, there are new jobs and interest rates remain relatively low.”

According to Real Estate Trends, typically, when the ratio of home-sales-to-new-listings moves above 50 — considered a sellers’ market — selling prices rise faster than inflation. 

Nationally, the sales-to-new-listings ratio breached this level in 1999,  the start of the current rising price cycle, and has climbed higher since. In contrast, during the 1985-89 housing boom, price increases were much larger than would otherwise be expected given overall market fundamentals.

“The regionally diverse nature of the current housing boom in Canada is also less indicative of an overvaluation than past cycles,” said Warren. “Between 1985 and 1989, average home prices were driven up by a spectacular — albeit unsustainable — 84-per-cent inflation-adjusted rise in Ontario.

“In the current cycle, all regions of the country are contributing to the rise in average house prices, and no province has yet experienced a real appreciation in excess of 60 per cent.”    

Actually, economists say the local Winnipeg market is playing catch-up — after years of relatively slow or no growth, home prices are increasing to reflect a market correction.

“We’ve seen some price increases in recent years, but we’re still very affordable in Canada,” added Boni.

Warren said Canada’s low, stable inflation environment also reduces the risk of a large real price correction. Nominal home prices tend to be “sticky”downwards, reflecting high search and transaction costs as well as the reluctance of homeowners to accept a capital loss. 

In Canada, national home prices have fallen in only seven of the past 50 years. Rather, any downward adjustment in real prices would likely occur gradually through inflation erosion.

Demographic factors have not been a major contributor to the run-up in national home prices, unlike the rising real price cycles of the 1960s, 1970s and 1980s. In fact, growth in the population aged 25-54 — those in their prime home buying years — has generally been slowing since the early 1990s. 

Looking ahead, the report said demographic influences could become mildly positive over the coming decade as the “baby echo” generation begins to enter the housing market.

Overall, the likelihood of a sizeable house price reversal at the national level is relatively low. Growth and employment prospects are reasonably good, supported by energy-related and productivity-enhancing business spending and multi-year government-sponsored infrastructure projects such as the expansion of the Red River Floodway in Winnipeg.

Foreign investment in Canada is on the rise, and the housing market is a clear beneficiary. With the strong Canadian dollar and global competitive pressures keeping a lid on inflation, monetary policy settings are expected to remain fairly accommodative. 

Past housing price declines have usually been preceded by a pronounced increase in shorter-term interest rates or a marked deterioration in labour markets.

“We anticipate a gradual moderation in the pace of price appreciation as demand slows and supply comes into better balance,” said Warren. “This would be consistent with the relatively orderly cooling off currently underway in several international markets, namely the U.K. and Australia where prices are now broadly keeping pace with inflation.

“On a regional basis, price trends will likely remain firmer in the Western provinces, supported by their relatively stronger labour markets, tighter supply-demand conditions and rising interprovincial migration inflows,” she added.

Alexander said the greatest risk in the housing market appears in Vancouver, where average home prices are rising at a 22-per-cent year-over-year pace which has deeply eroded affordability and has likely contributed to the decline in the B.C. personal savings rate going deep into negative territory.