June 13, 2005

Blurb: The housing market continues to show surprising resilience, but Canadians are paying for them by taking on more debt

Real estate still hot, but households face greater risk

By Peter Diekmeyer o Bankrate.com

Lead: Despite the fact real estate prices are at or near record levels in many key municipalities across the country, Canada's housing market is heading to this year's mid-point showing continued strength.

Home sales and new home construction are both going great guns, a trend that experts say is likely to continue. However there are increasing signs that Canadians are exposing themselves to greater amounts of risk in structuring their personal finances.

House prices still hot

For existing homeowners the news is all good. The number of houses sold via the Canadian Real Estate Association's Multiple Listing Service rose by 4.2 percent during April to 40,140 units. And the average selling price jumped by an impressive 8.7 percent on a year-over-year basis to $248,563.

Gregory Klump, CREA's chief economist predicts that strong home sales and pricing power will continue throughout 2005, which should come in as the industry's second strongest year on record. "Low interest rates are continuing to fuel housing market activity in all regions, says Klump, adding that further price increases and an expected rise in rates will dampen activity in the second half of the year.

New home building also continued to go great guns, with 218,800 units started during the month of May. Although this was down slightly from the previous month, new home construction continues to hover at historically high levels.

Canadians adding risk to their balance sheets
The bad news is that according to the Bank of Canada's Financial System Review released late last week, Canadian households are continuing to add to the amount of risk that they are exposing themselves to.

In recent decades there has been a gradual shift, with an increasing proportion on total household wealth invested in assets subject to market risk, such as stocks, mutual funds and real estate. At the same time, Canadians are putting less money into relatively secure investments such as bank accounts and foreign currencies.

This comes at a time when Canadians are less sure of who will fund their retirements than ever before. According to the Bank of Canada, the number of Canadians with access to an employer sponsored pension plan has fallen from 40 percent during 1992, to less than 35 percent by 2004. To compensate, Canadians have been increasingly putting money into private registered pension plans such as RRSPs, where their exposure to market fluctuations is far greater.

Canadians' increasing preference for variable rate mortgages is another factor that increases their risk exposure. The bank estimates that variable rate mortgages comprised just under 30 percent of the total during 2004, an increase from just 5 percent during 1999.

However while variable rate mortgages cost less than their fixed rate cousins, they leave mortgage holders exposed to large interest rate fluctuations.

But interest rates remain historically low
The good news is that Canadian interest rates continue to hover at very attractive levels, which makes it easier for mortgage holders to meet their obligations as they become due. At its last meeting in late May, the Bank of Canada decided to keep its key rate at 2 1/2 percent, the fifth consecutive time it has declined to act.

Earlier this year, experts had expected the Bank of Canada to follow on the heels of the U.S. Federal Reserve Board and begin to tighten up, but these actions never materialized. Although interest rates are expected to rise by year-end, such increases are likely to be modest. For example National Bank Financial, predicts just two 25 basis point increases between now and December.

Despite the increasing risk that Canadians are exposing themselves to in their portfolios, the exposure is unlikely to be a serious cause of concern to the overall economy. After all, the net worth of Canadian households has more than doubled since 1980 and has increased more than disposable income, leaving them in a better position to weather market storms.


But if Canadians' tastes for larger debt levels and volatile financial assets increases, that could change.

Peter Diekmeyer (www.peterdiekmeyer.com) is the Montreal Gazette's management columnist.



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