Diving deep into the housing market

Recently, Finance Minister Bill Morneau said he would "deep dive" into Canada's housing market to find out what’s really affecting record-high prices, arguing that if the government is going to make any changes, then it should be evidence-based. So let’s look at some of the “evidence”.

Interestingly, Morneau divides the housing market into four parts. The stable market, which is a significant portion and includes Montreal and Ottawa; the strong part, which includes the Toronto region where housing factors are moving quickly; the "very strong part", which is Vancouver and nearby areas; and the areas that are not doing so well because of the downturn in the oil industry. Then there is, of course, the foreign investment factor.

Overview of current housing market

The state of the Canadian economy has changed, and so too has the housing market. A look at the Statistics Canada website shows some interesting numbers: As of May, the unemployment rate is down; retail sales are up slightly; manufacturing sales are up slightly; and average weekly earnings are up, slightly. These are all good indicators that the economy is growing – but not as robust as it grew prior to the 2008 recession, but growing nonetheless.

In Mortgage Professionals Canada (MPC) Spring Report, Looking for Balance in the Canadian Housing and Mortgage Markets, it found that the number of adults with jobs is lower now that before the recession. So what accounts for the hot housing markets in parts of Canada? The real difference is now we have low interest rates, which have fuelled the housing market, and indeed, has kept the Canadian economy humming along for quite some time. We also have some indication that foreign investment is adding fuel, as well as a lack of supply.

If we take all the factors above and match them to the four parts of the housing market that Morneau mentioned we find the following:

• In Toronto and Vancouver there is higher population growth. The labour markets are better there and there is much lower unemployment but there are housing supply issues.
•  In the stable areas of the country there is balance in the labour market and adequate housing supply and demand.
•  In the areas impacted by the oil industry, lower rates are not effective because there are issues with unemployment. 

Because the housing market has been under-supplied for a long time (this is a major factor that has fueled prices in both Vancouver and Toronto – lack of supply for single family homes) the result has been a long period of rapid price growth, according to the MPC report. "The recent surge in sales has, once again, sparked a very high sales-to-new-listings ratio, and the rate of price growth has accelerated."

 Housing Bubble Revisited

It's inevitable that, along with reports of a hot housing market, a discussion of housing bubbles follows. But what, exactly, is a housing bubble? Well, it's characterized by property quickly becoming overvalued until it reaches a level that is unsustainable relative to income and other factors including employment. That rapid rise is quickly followed by property value decreasing to where homeowners owe more than the property is worth. What tends to follow is that homeowners, depending on their financial situation, will try to sell the property or will simply stop paying the mortgage, resulting in an influx of foreclosures in the market.

By that definition we could be in a bubble except for the other factors, namely, job numbers and earnings, both of which have risen in recent months. It's when unemployment rises, interest rates increase and house prices continue to rise that trouble follows. Certainly low mortgage interest rates have fuelled some of the increase in activity; however, the increased prices in the high-end markets are still skewing the average. Eventually, those high-end prices are expected to moderate and there are signs that it’s starting to happen.

Government Intervention

 As the Finance minister dives deep into the industry, Mortgage Professionals Canada (MPC) is cautioning the government against regulations that might "cool" the market. MPC said that another clampdown on mortgage lending rules in Canada could unnecessarily cause housing prices and demand to plummet – and even "bring consequent economic damage" to the country.

 "Now that the energy sector is no longer a major economic driver, a healthy housing sector is even more essential," Will Dunning, chief economist with Mortgage Professionals Canada, said in a statement.

 Morneau announced that Ottawa was forming a working group with provincial representatives from Ontario and B.C., as well as municipal officials from Vancouver and Toronto, to study Canada's booming housing market and would evaluate whether further steps are needed to protect borrowers and lenders to help maintain a stable housing market.

Since 2008, Canada has tightened mortgage regulations five times, shortening the length of loans and hiking minimum down payment rules.

Mortgage Professionals Canada sees no substantial evidence of a widespread increase in risk taking by borrowers or lenders for these reasons:

• Data from the Canadian Bankers Association shows a very low rate of mortgage arrears, just 0.28% or one per 354 mortgages
• Survey data continues to show that Canadians are highly motivated to pay off their mortgages as quickly as possible 
• At current very low interest rates, regular mortgage payments result in accelerated pay down of mortgage principal. At a current typical interest rate of 2.5%, 2.9% of the principal is repaid in the first year. 

 Bottom Line 

A home is a long term investment and its value will fluctuate up and down over the course of your tenure in it. The housing market right now is at a precipice – when high prices and lack of supply deter home buyers and potential home sellers wait out the market, then we’ll start to see moderating prices, as economists have been predicting for the last few years. One thing we know for sure is that low interest rates are here to stay for at least another year, which will be a boon when the market becomes more robust and affordable.

Talk of housing bubbles may be just hot air

The latest housing price statistics from the Canadian Real Estate Association (CREA) has created a buzz in the media and talks of bubbles and an overvalued housing market have resurfaced.  According to CREA, the average house price has risen 5% over last year.

What that number does not show, however, is the lowered house prices in many markets such as Saint John and Victoria, for example. The red-hot markets in Vancouver, Calgary and Toronto are skewing the average according to CIBC economists Benjamin Tal and Avery Shenfeld and more than one-quarter of the sales are now in cities where house prices are increasing by less than the current rate of inflation – approximately 2.10 percent in August of 2014.

The CREA stat is no reason to panic once the numbers are broken down. The majority of that price gain are for high-end homes in the most expensive cities in the country—Toronto and Vancouver, said Avery Shenfeld in a Globe and Mail article and in the “their urban cores, as opposed to lower-priced alternatives in the suburbs.”
Evan Siddall, CEO of Canada Mortgage and Housing Corporation (CMHC) also sees no need to worry. Interestingly CMHC has a Housing Price Analysis and Assessment tool that gauges the housing market and takes into account the following:

•  Overheating of demand in the market

• Acceleration in prices

• Overvaluation in prices

• Overbuilding

The assessment of Canada’s housing market at the moment shows no immediate problems at the national level. Sidall was quoted as saying, “Our educated opinion is that growth in house prices in Canada will moderate.”

This opinion is shared by many in the industry. John Bordignon, EVP, Strategic Development at Paradigm Quest says it boils down to supply and demand. “Certainly low mortgage interest rates have fuelled some of the increase in activity,” he said. “However, when we analyze the market, we can see that the increased price in the high-end market are skewing the average and cannot be sustained simply because that same price appreciation is not occurring in the move-up market.”

At the high-end of the housing spectrum we have a seller’s market, he explained – more buyers then there are homes, which would naturally increase the price. However, tighter mortgage lending guidelines coupled with changes to mortgage insurance regulation have priced out first time home buyers, making it more difficult for the move-up market to move. Higher prices at the top-end may be also causing some affordability issues among those considering a move up.

“Eventually, those high-end prices should moderate – when there are no buyers, prices come down, which is happening to prices in the mid-range due to fewer first time buyers.”

The two stats that bode well for Canada’s housing market according to Bordignon are employment levels and low interest rates. “Corrections occur when unemployment rises, interest rates increase and house prices continue to rise. Here in Canada, we have stable employment levels and interest rates are still relatively low.

Despite the talk of bubbles, resale activity has been relatively stable over the past few years. Unit sales have fluctuated between 35,000 and 40,000 units per month according to a report by CIBC’s Benjamin Tal. Sales of units at the low-to-mid price range have fallen notably since 2010. Sales for the mid-to-high price range have risen modestly and sales for the upper end of the market have increased rapidly.

“In the Toronto market, for example, we see that the more expensive the property is, the faster its price rises,” Tal said. “A household that owned a single-detached property valued at say $600K and would like to move up, would have to pay extra not only for the jump in category, say $900K, but also for the fact that the price of the move-up property has risen faster than the price of their own property.”

Despite all the talk of the ups and downs of house prices, the mortgage lending market remains robust. Mark Kerzner, President of TMG The Mortgage Group has watched activity in housing market rise and fall for many years and although tighter regulations over the past few years have slowed activity somewhat, overall the market is healthy.

“We’ve had a low rate environment for many years now, and while fixed rates are poised to increase due to higher bond yields, ARM discounts are also increasing thereby making ARMS more attractive. We anticipate PRIME will likely stay low into the first half of next year as the Bank of Canada stays the course with its benchmark rate that’s still at 1%,” he said.

Kerzner also highlights the fact that the Canadian economy is healthy and affordability is in check despite the increased regulatory insight. “Qualified buyers are still able to access very low rates and lenders are offering a variety of mortgage products to suit the needs of more buyers,” he said.

“If we examine the current situation we see low interest rates, a housing market where the prices in most markets are stabilizing, a healthy economy that is growing and an inflation rate that is holding steady,” he said.

“The most important factor is your personal readiness.  A home is a long term investment and its value will fluctuate up and down over the course of your tenure in it. It is both a commitment and an achievement that reflects your aspirations and lifestyle, and offers a great deal of personal satisfaction, as well as financial stability.”

Yes, prices have increased in a few cities so it’s important to analyze what’s going on in your local market because all real estate is local. Mortgage rates and house prices will fluctuate but over the long term, homeownership is a sound investment that compares well with other investments. When you invest in mutual funds, the mantra for most is buy and hold. Similarly, your home is a buy and hold investment.