Canada’s housing market is trapped within a high-priced bubble, vulnerable to interest rates, global instability and rising debt: this is one of the most widely accepted truths regarding Canadian housing, touted by many a headline and economic pundit.
However, the idea that Canada’s market is a red-hot, debt-inducing buyer’s nightmare has been challenged by Will Dunning, chief economist at CAAMP and one of our expert Mortgage Rate Outlook Panelists. In his new paper “How To Dissect A Housing Bubble”, Dunning counters some of these commonly held ideas, and questions the data they’re based on.
The claim turning the most heads: Canada’s housing market isn’t overpriced at all… and may even be undervalued.
Here’s a look at Dunning’s main arguments – do they change YOUR thoughts on the cost of housing in Canada?
No Doubt About It… Housing Is Expensive
This isn’t to say that housing prices in our country aren’t steep, and getting worse; recently, the Canadian Real Estate Association found the average home price will total $397,000 this year, a 3.8 per cent increase from 2013. A Bank of Montreal report has also found that first time buyers have become resigned to ponying up more cash for their first purchase – up to $316,000.
Buyers in Toronto and Vancouver, Canada’s priciest markets, may find these new affordability claims tough to swallow – though Dunning does concede that certain regional markets live up to the high-priced hype.
“In Vancouver, the housing market is fully valued, in that prices are at the maximum level that is consistent with current interest rate,” he says in an interview with Money Wise. “In Toronto, there is about one-half of a percentage point available to absorb rising interest rates. A sharp rise in interest rates or a fall in employment could cause prices to fall in Vancouver or Toronto. Elsewhere, there is substantially more capacity to absorb higher interest rates.”
So why does Dunning believe prices have room to grow in other Canadian markets?
Calling Data Into Question
One of the benchmarks used to determine buyer affordability is the ratio between rental rates and home prices. The Organisation of Economic Co-Operation and Development has relied on this data in its prognosis of the market, but Dunning pokes holes in its validity. “To be blunt, while the OECD has relied on data that it might consider the best available for the purpose, the data in reality is badly flawed and results in wildly inaccurate estimates,” his report states.
He refers instead to data compiled by the Royal Le Page House Price Survey which cites a lower rent to price ratio, and finds that the gap is so large the market can “accommodate a sizable increase in house prices (as much as 20% to 25% during the next two years) and/or rises in interest rates (as much as one percentage point from current levels).”
Posted Rates Paint A Darker Picture
Dunning’s report also looks to a number of affordability indexes, calling into question their use of posted mortgage rates to determine market factors. Posted rates can be much higher than the discounted mortgage rates available to savvy consumers – sometimes as much as 60 – 70 basis points.
States his report, “For that reason, the indexes overstate the cost of home ownership in Canada. Moreover, due to the evolutions of actual interest rates versus posted rates, these indexes overstate the extent to which affordability has changed in recent times. When affordability is measured using the interest rates that exist in the market, it is clear that conditions are much better than is generally believed.”
An Interest Rate Hike Will Not Be The End Of The World
An oft-warned consequence of a too-hot housing market is the creation of mortgage debt. The fear is Canadian household debt levels are so high that our nation is vulnerable to macroeconomic shock.
Consumers have been told to heed possible interest rate increases, as they may make existing mortgages unaffordable and lead to an onslaught of mortgage defaults.
Not so says Dunning, who states that “Canadians are well aware that interest rates can rise,” and that buyers have been prudent in years past. “To fight against growth of mortgage debt would mean fighting against growth of the economy,” Dunning says.
“Canadians can afford the mortgages they have. The share of our national income that goes to paying interest on mortgages and consumer debt is at the lowest ever!”
Ottawa Shouldn’t Have Intervened In Market Demand
The Department of Finance has implemented buyer restrictions designed to cool the market four times, most recently last summer when they maxed amortizations for high ratio buyers at 25 years, tightened the debt ratios for qualification, and limited the amount of money available through HELOCs.
Dunning states that not only were these measures unnecessary, they were dangerous.
“In particular, the fourth round of changes, which took effect in July 2012, took demand out of a housing market that was already in a state of balance,” he reports, adding that the amortization cap is equivalent to a one point mortgage rate percentage increase.
He says the true effects of these measures are only now being realized. “Resale market activity is substantially lower than it should, based on economic conditions and the level of interest rates,” he says. “The impact that is still developing is in new construction – housing starts – which takes longer to adjust. The drop in housing activity will cost jobs across Canada, and that effect will develop well into next year.”
Do you think the Canadian housing market is overvalued? Share your thoughts in this week’s #RSMWIN poll, and you could WIN a $25 gift card!