Two new studies released by Canadian banks this week say that although the housing market is still booming, price gains are moderating to a more sustainable level. But in red-hot Vancouver, where prices have been appreciating by 22 per cent a year, there may be trouble looming for investors.
"In contrast to Central and Eastern Canada, housing conditions in Western Canada remain very tight and are showing increased signs of speculation," says Craig Alexander, vice-president of TD Bank Financial Group. "When economic conditions are booming, it can also create the perfect breeding ground for speculative price bubbles to form. That's because in such an environment, housing market participants are at greater risk of developing a case of irrational exuberance, especially if they expect that such exorbitant price gains will continue indefinitely."
Alexander's report says that Vancouver's average home price is now at an all-time high of almost half a million dollars, the highest in the country. "In addressing the matter of a speculative housing bubble, the more important question to answer is: are these robust economic fundamentals in Vancouver strong enough to support such price gains? Based on a number of indicators, we still don't think so," says Alexander.
The report says affordability is deteriorating in Vancouver despite low interest rates, and although the local labour market is strong, it isn't robust enough to offset the rapid rise in house prices. "As an aside, this is in sharp contrast to cities like Calgary where home prices are also accelerating, yet extremely robust income growth has helped to keep that city's affordable rates relatively stable," says Alexander. He says that B.C.'s provincial savings rate hit an all-time low of -7.9 per cent in 2004 "and likely retreated further since then."
That's also the worst rate in the country and suggests that, on average, potential homebuyers in Vancouver may be forced to carry a far greater debt load than other Canadians simply to own housing."
He says: "If the U.S. housing markets continue to weaken, as we expect they will, this could act to temper the speculative activity in B.C. real estate markets, as the U.S. media coverage will remind buyers that prices don't just go up."
The report says that while sales in Ontario, Quebec and the Atlantic provinces are still high, the pace of price growth has slowed (currently to about three to four per cent annually in Toronto and Ottawa). "This is consistent with the view that a speculative bubble never developed in these regions and moderation in housing activity is likely to remain orderly."
Canada's housing boom has lasted for seven years, resulting in a 40 per cent rise in the national average home price when adjusted for inflation, says another report by Adrienne Warren, senior economist with Scotia Economics.
She compared the price gains from this housing boom to three previous cycles of rising housing prices, and concluded that the current price gain isn't unusual. The average price gain over the prior three cycles was 44 per cent. But what everyone wants to know is what happens next.
After the first boom, in the 1960s, prices dropped by about three per cent. After the booms in the 1970s and the most recent one from 1985 to 1989, prices fell by about 20 per cent, says the report.
Warren says the risk of a "correction" in house prices rises as the current cycle ages, and as interest rates edge up. She also acknowledges that some regions of the country are more at risk than others.
But she says, "The likelihood of a sizeable price reversal is still relatively low." She notes that growth and employment prospects are good, foreign investment in Canada is on the rise, and the strong Canadian dollar and global competition are keeping inflation down. "Past housing price declines have usually been preceded by a pronounced increase in shorter-term interest rates or a marked deterioration in labour markets," which isn't happening this time, says Warren.
"We anticipate a gradual moderation in the pace of appreciation as demand slows and supply comes into better balance. This would be consistent with the relatively orderly cooling off currently underway in several international markets," says Warren. She says prices in the U.K. and Australian markets are now keeping pace with inflation.
"Looking past the short-term price risk inherent in essentially any asset -- real or financial -- there is little doubt that housing represents a good long-term investment," says Warren. "Since the mid-1950s, real home prices in Canada have increased, on average, just over two per cent per year … . Of course, home ownership also carries intrinsic value beyond its investment potential, including lifestyle benefits."
