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Are fears concerning imminent drop in house prices in Canada overblown?

Are fears concerning imminent drop in house prices in Canada overblown?

Topic of the week

For several months now, various analysts have expressed fears regarding the residential real estate sector in Canada based on ratios of house prices to income or rent. In our opinion, these analyses do not paint a correct picture of the situation in that interest rate levels were not taken into account. To our eyes, the recent advance in house prices in Canada is due to record-low interest rates at a time when the labour market has registered one of the best performances among the advanced countries since 2007. What’s more, Canada’s demographic profile is playing in favour of the housing sector given that the cohort of first-time homebuyers is presently growing at one of the fastest rates among the advanced countries. Based on our calculations, in order to purchase an average-priced property today in Canada, the average household must spend 28.7% of its disposable income, a level shy of the average since 1997 (28.9%) and well below the 35.1% mark reached in 2007. As for the three largest Canadian cities, the monthly mortgage payment relative to income is also well below what it was at in 2008. In sum, the growth of house prices in Canada in recent years seems to reflect the country’s economic fundamentals. Consequently, provided that Canadian economic expansion is not undermined by a global credit crisis, an imminent house price correction is rather unlikely. However, given that real estate has fared quite well as an asset class over the past few years, any price acceleration in future could be the sign of undesirable speculative activity. Over the past decade, Canadian households have benefited from a substantial wealth effect from real estate but conditions are less conducive to gains over the next ten years given that interest rates are expected to rise and demographics should take a less favourable turn as far as housing is concerned.

Summary

  • For several months now, various analysts have expressed fears regarding the residential real estate sector in Canada based on ratios of house prices to income or rent. In our opinion, these analyses do not paint a correct picture of the situation in that interest rate levels were not taken into account.

  • The recent advance in house prices in Canada is due to recordlow interest rates at a time when the labour market has registered one of the best performances among the advanced countries since 2007. What’s more, Canada’s demographic profile is playing in favour of the housing sector given that the cohort of first-time homebuyers is presently growing at one of the fastest rates among the advanced countries.

  • Based on our calculations, in order to purchase an averagepriced property today in Canada, the average household must spend 28.7% of its disposable income, a level shy of the average since 1997 (28.9%) and well below the 35.1% mark reached in 2007. As for the three largest Canadian cities, the monthly mortgage payment relative to income is also well below what it was at in 2008.

  • In sum, the growth of house prices in Canada in recent years seems to reflect the country’s economic fundamentals. Consequently, provided that Canadian economic expansion is not undermined by a global credit crisis, an imminent house price correction is rather unlikely.

  • However, given that real estate has fared quite well as an asset class over the past few years, any price acceleration in future could be the sign of undesirable speculative activity. Over the past decade, Canadian households have benefited from a substantial wealth effect from real estate but conditions are less conducive to gains over the next ten years given that interest rates are expected to rise and demographics should take a less favourable turn as far as housing is concerned.

source:Economic and Strategy Team  - National Bank of Canada