Housing Prices Due To Fall, Says Think Tank

Housing prices due to fall, says think-tank

By Tony Wong Business Reporter
Published On Tue Aug 31 2010

Canadas major metropolitan housing markets are looking awfully bubbly and are due to burst, says a report released Tuesday.

The report, entitled Canadas Housing Bubble: An Accident Waiting to Happen, by the Canadian Centre for Policy Alternatives, looks at prices in Toronto, Vancouver, Calgary, Edmonton, Montreal and Ottawa.

It concludes that housing price appreciation is frothy in comparison to historic values.

I think at best you will see stagnation in housing prices or some kind of correction, and at worst you will see the bubble bursting, said David Macdonald, an economist and research associate at the centre.

Housing bubbles emerge when prices increase more rapidly than inflation, household incomes and economic growth. That has been the case for Canada over the last run-up in prices, according to the report.

Macdonald said this bubble is different than others, because for the first time it is spreading beyond Toronto and Vancouver.

Canada is experiencing for the first time in 30 years a synchronized housing bubble across the six largest residential markets, he said.

Major banks have reached conclusions similar to those of the left-of-centre think tank. The Toronto Dominion Bank has estimated that average prices are 10 to 15 per cent too high, while the CIBC has said prices are 14 per cent overvalued.

Canada has only had three bubbles. Toronto experienced a large bubble in 1989, while Vancouver had two burst in 1981 and 1994.

Macdonald said a full-blown crash can still be avoided if mortgage rates do not ratchet up quickly and if government puts more stringent requirements on lending.

He said legislation could be introduced to return mortgage lending to 2006 criteria, where purchasers had to put 10 per cent down for a 25-year amortization. Although the federal government already put tighter restrictions in place earlier this year, buyers still have the option of putting 5 per cent down and can take a 35-year amortization on homes.

Consumers should also play a part by not buying more house than they can afford, says Macdonald.

The report says the last bubbles were triggered by interest rates moving up by just one per cent above the two-year rolling average.

It doesnt take much for consumers to take pause, especially those who are used to seeing such low rates, said Macdonald. You also have a lot of consumers, particularly outside Toronto and Vancouver, who have no memory of what a bubble is like or the aftermath.

Low mortgage rates, access to easy credit and net immigration have also contributed to price pressures, said Macdonald.

Between 1980 to 2000, the historical price range for housing stood at between $50,000 and $80,000 in inflation-adjusted 1980 dollars. But within a brief five-year period from 2001 to 2006, major housing markets shot to well above that $80,000 average, according to the report.

The comfort level isnt there as affordability erodes, said Macdonald.

Housing prices have stayed in a narrow range of 3 to 4 times income in the 20 years before 2000. The problem is, says Macdonald, is that housing prices adjusted for income today are anywhere from 4.7 to 11.3 times annual income in the six major areas.

Not everyone agrees with the findings of the report.

Toronto economist Will Dunning says that the market cycle is in a cyclical downturn not a bubble.

It is quite possible that the next phase of the cycle will be a partial reversal of the price gains of maybe 5 to 10 per cent, but this is not a post bubble collapse, says Dunning.

It is the operation of a functioning market in which the vast majority of buyers are making decisions based on their real needs, not the mindset normally associated with bubbles.

Despite their differences, all analysts seem to agree that prices could fall.

Macdonald gives three scenarios in which prices might drop. The first is similar to what happened in Vancouver in 1994, a market correction through price deflation.

In that scenario, Toronto prices would decline by 9 per cent from an average of $420,000 to $382,000.

In the second scenario, the bubble would burst more slowly, similar to the 1989 Toronto bubble. In that case, prices would decline by 21 per cent from $420,000 to $330,000 over a five-year period.

In the worst scenario, a bubble would form similar to the United States and prices would fall rapidly. In that case Toronto prices would drop 20 per cent over three years to $335,000. The price drop would be slightly less than in scenario two, but happen more rapidly.

Bringing house prices down just enough to moderate expectations but not so much as to cause a panic is a delicate balance, says the report.

Government policy makers, the Bank of Canada, as well as rate setters at the big banks need to work together to steer the Canadian market to a soft landing. The alternative is not acceptable.