Bankrate.ca

 

August 2012

 

Title: Housing looks to be levelling off

Sub-title: Exports say that real estate could lose ground in coming years, but the landing is expected to be soft.

 

Recent data are providing additional ammunition to forecasters who have been predicting that the Canadian residential real estate sector is headed for a correction. Both housing starts and existing home sale prices fell during July. As if that were not enough, the Canada Mortgage Housing Corporation forecast that new home construction will slow.

 

The prospect of falling housing prices may seem unreal to Canadian residential real estate owners, many of whom who have gotten accustomed to a more or less steady uptrend over the years. According to the Canadian Real Estate Association the price of the average home sold in Canada was $353,147 in July of this year, up 86.8 percent compared to the $188,754 average price paid ten years earlier (in 2002).

 

In fact, housing has outperformed all major investment categories – notably stocks and bonds, - during that time. That gap is even wider when you consider that residential real estate gains are generally tax free, while returns on other investments during the past decade (even those in RRSPs, for which tax gains are deferred, not eliminated) are not.

 

Too much of a good thing?

But there is an old economics expression that says “if something cannot go on forever –it won’t,” that applies to housing here, which is now overvalued by numerous measures. According to the Economist Intelligence Unit, which compares residential real estate in 21 world markets, Canadian prices are 77 percent overvalued relative to rents and 32 percent overvalued relative to average household incomes. That makes the Canadian housing the most aggressively priced among major markets.

 

As Aron Gampal, Adrienne Warren and Mary Webb, economists at Scotiabank note in a recent report to clients, there is some good news though.  Canadian homeowners’ equity in their real estate assets averages 67 percent, compared to just 41 percent in the United States. In addition delinquency rates here remain low. However high Canadian household debts levels which rose to a record 152 percent of personal income in the first quarter of this year, cause considerable concern.

 

As a result, real estate valuations look set to cool. “Record prices, combined with incremental regulatory tightening are reducing affordability,” note the Scotiabank economists. “Pent-up demand has been effectively exhausted after a decade-long housing boom, with Canadian home ownership at record levels.”

 

Gregory Klump, chief economist at CREA cites potential first time homebuyers, who may have difficulty qualifying for new mortgage financing due to recent rule changes, as a group whose activity could have spin-off effects on the market as a whole.

 

While a housing sector correction may seem like a terrible thing, particularly for new buyers, when markets are significantly overvalued, as Canada’s may be, they are far better than the alternative. One has only to look at the United States, where average selling prices have fallen by more than a third since peak levels.

 

And that drop wasn’t just temporary. During recent weeks, experts have been speculating that US housing prices and housing starts now look like they are forming a bottom – but that comes after a more than five year downtrend. In short, a mild correction in Canada now, followed by an extended pause, could be far better than an outright plunge.

 

How big will the correction be?

That said, the degree of the correction that Canada faces is less clear. The CMHC’s deputy chief economist Mathieu Laberge is moderate in his outlook, and projects prices will actually rise, though less fast than in the past. The CMHC’s point forecast is for 207,200 units in housing starts in 2012 and 193,100 units in 2013.

 

Scotiabank for its part is far less optimistic and expects that home prices could fall by as much as 10 percent over the coming years, with the drops concentrated in the frothy Toronto and Vancouver markets. If that’s true, other regional markets, which gained far less on the upside would thus be also far less affected on the down end.

 

The upshot is that the Scotiabank economists, like many others, expect Canada’s housing sector will feel some pain, but will avoid the sharp downturns seen in the United States and Europe.

 

Let’s hope they are right.

 

Peter@peterdiekmeyer.com

 

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