I mean, crash or soft landing? It’s a coin toss! A recent poll conducted by Reuters suggests that Canada’s home prices will fall 10 per cent over the next several years while home building will drop sharply by 17 per cent in 2013. This is what the majority of respondents are saying, while some are suggesting a 25 per cent decrease in prices and a plunge in housing starts.
The poll surveyed 20 forecasters and the majority believe that the Canadian government has done enough to control prices. Craig Alexander, chief economist at TD, thinks that a “10 per cent correction would be healthy.”
Healthy, O.K… But is it Likely?
Think about the teeter-tottering effect on prices when you consider the opposing pressure that lower interest rates have (upward pressure) vs. new mortgage rules (harnessing demand and therefore decreasing pressure). Are the effects offset? This is a question that economics can answer! And I’d like to challenge the idea with a simple depiction of how these poll results could actually lead to an increase in prices.
Lower interest rates make financing cheaper and therefore housing more affordable. When something is more affordable, people buy it! This increases demand (shown below).
The net effect is an increase in prices. This is what the Canadian economy has been experiencing for some time now, case and point: Vancouver and Toronto. As this problem progressed into a national issue, the Government of Canada reacted.
New Mortgage Rules
They reacted with the introduction of new mortgage rules which made financing tougher to obtain. Since less people are being approved for mortgage financing, less people are able to purchase a home which dampens demand. This decrease in demand is not necessarily by consumer preference, but the outcome of fiscal policy changes by the Government.
No financing = no purchase = no house. This cools demand and prices retract. “Ahhhhh” – says the Government.
Poll: Decrease in Housing Starts
With no mentioned change in demand in terms of population growth/decline or changes to net migration, a decrease in housing starts is pretty easy to understand as it is simply a decrease in supply.
As you can see when there is a decrease in the supply of housing but no change to the demand for housing, (since the lower interest rates and new mortgage rules somewhat offset one another in this example) prices increase! So there you have it. The 17 per cent decrease in housing starts would in theory drive prices upwards.
But Wait … There’s One More Thing
There is currently excess supply in the market as housing starts haven’t let up. What does excess supply mean and how do we fix it? When house prices are inflated, people want to sell or supply them! However, people aren’t as interested in buying.
As you can see, at P1 the quantity supplied is greater than the quantity demanded which creates a supply gap. Whenever there is excess inventory that is not selling at a set price (P1) the natural move for the sellers would be to decrease the price making it more desirable to consumers. As they discount prices further and further, more people will be willing to buy. This adjustment will continue until the market rests at the equilibrium level.
Lower interest rates and the new mortgage rules will hypothetically offset one another. The decrease in house starts would signal prices to increase, however an excess supply would cause prices to decrease. Economists say that 175,000-185,000 housing starts are needed per year to keep up with population growth. Therefore a 17 per cent decrease to sit at 184,000 units would help stunt the over-supply and help move towards the equilibrium sooner than later.
RateSupermarket.ca Week in Review
No change this week for our most popular five-year fixed and variable rates – both have held consistent at 2.84 per cent and 2.55 per cent respectively. One-year mortgage rates have also held steady, with fixed seeing no change from last week’s 2.39 per cent, and variable’s three per cent. Those looking for three-year rates have reason to cheer, though, as fixed three-year slides two basis points to 2.75 per cent, and variable dips considerably to 2.65 per cent.