Toronto prices are in balance
But Canadian residential real estate is overvalued by as much as 25%, a study warns
Canadian homeowners should be prepared for a fall in housing prices, warns a study that estimates homes in most cities are overvalued, and by as much as 25%. With the exception of Toronto and Edmonton, houses in Canada’s major cities are overvalued by anywhere from $32,000 to $87,000, says the study of prices in nine cities by researchers at the Sauder School of Business at the University of British Columbia.
The study released today, looked at prices for single-family homes in the second quarter of this year in nine major Canadian cities, and compared prices in those cities with what they would be in a balanced market based on the relationship between house prices and rents.
Only in Toronto are prices in balance with rents, the study concluded. In Halifax, Montreal, Ottawa, Regina and Winnipeg prices would need to drop by at least 20% to be in balance and in Calgary by 7% and in Vancouver by 11%.
In contrast, Edmonton prices are actually below equilibrium, and would have to rise by 8% to be in balance, it said.
“The decade long boom in Canadian markets is over,” Tsur Somerville, the study’s lead author.
Housing affordability is a severe problem in some Canadian cities, limiting the ability of markets to continue to rise, says the report titled “Are Canadian Housing Markets Overpriced?”
The rapid price increases in many Canadian cities since 2001 along with the downturn in the U.S. housing market has raised concerns about the future of housing markets here, it noted.
“There are parallels between the path of house prices in Canadian and U.S. markets,” it said. During the U.S. housing boom, which ran from 1997 to 2006, prices rose 132%, while in Canada over the 2001-08 boom prices in the nine cities rose by an average of 87%.
While Canada’s more conservative lending practices have prevented the speculative excess and severe downturn experienced in U.S. markets, they haven’t prevented homes from becoming overpriced, it said.
The assessment of whether a housing market is in balance or equilibrium takes into account the ratio of rent to prices, mortgage rates and the cost of owning a house, and the expected long-term price appreciation.
In dollar terms, the amount by which house prices would have to fall to bring them back into balance in each of the overpriced cities was: Calgary $32,000, Halifax $58,000, Montreal $68,000, Ottawa $81,000, Regina $87,000, Vancouver $85,000 and Winnipeg $74,000.
That houses are overpriced doesn’t, however, guarantee that they will fall, it said.
“Instead the market could return to equilibrium through an extended period of housing price appreciation that is above zero, but below the long run rate,” it said.
The potential for price declines is greatest in cities that have a large supply of unsold inventory or a mismatch between the number of units and the number of households ready to occupy them, it says, adding that by that criteria Vancouver is the most at risk of a housing price correction, though compared with most of the other cities the decline would be relatively moderate.
While the study looked at prices for single-family homes, it noted that a concern in some housing markets is that the buyers of units are not living in them, it added.
“If markets turn, these investor-buyers might behave in a manner akin to other asset markets, dumping their units to avoid future greater perceived price declines,” it said. “In contrast, owner occupiers, unless forced to sell, can remain in their units and wait out a weak market.”
In contrast, prices in Edmonton would have to rise by $32,000 to bring them back into balance, and that’s despite what has been an annual increase in prices of 13.4% during the 2001-08 housing boom.
Annual price increases during the 2001-08 housing boom for the other cities studied were 14.5% in Regina, 12.4% in Calgary, 10.6% in Vancouver, 10.2% in Winnipeg, 8.1% in Montreal, 5.7% in Halifax, 5.7% in Ottawa, and 7.2% in Toronto.
Prices have doubled in last decade
A majority of Canadian homes have nearly doubled in value over the past decade, though price appreciation in the country’s urban markets has been more pronounced, a Royal LePage survey has found. The country’s most impressive gains were found in Edmonton, where the average price of a condominium tripled in price in the city and more than quadrupled in the suburban areas, Royal LePage’s ‘Urban vs. Suburban’ survey revealed.
The survey examined 32 urban and 26 suburban markets across the country and found the average price of a standard two-storey home in an urban neighbourhood appreciated by 129.2% to $522,999 over the last decade, while the same property in a suburb rose by 110% to $334,380.
The highest price appreciation was seen in Castledowns, Edmonton, where the average price of a condo rose 633%. A condo in the Edmonton suburb of Sherwood Park increased 416%.
“A look back at the last 10 years in Canadian real estate growth reveals that typically, home prices in urban markets have grown faster than those in the suburbs, with both areas showing impressive appreciation,” said Phil Soper, president and chief executive of Royal LePage Real Estate Services. “This decade has provided Canadians with the historically longest housing market expansionary cycle in the nation’s history.”
He said strong demand for amenities and limited supply in city centres have spiked prices upwards in urban areas, while affordability and spacious yards continue to attract buyers to the suburbs.
Factors driving price appreciation in the country’s urban neighbourhoods generally included limited property availability, a desire to be near the workplace, diverse amenities and, more recently, the rising cost of fuel.
Suburban price appreciation has mostly stemmed from the relative affordability of areas that are removed from the city core. The availability of affordable, larger properties with garages and more green space also appeal to buyers.
In Montreal, the combination of a shortage of inventory and virtually no space for new development led to the significant gains that the city experienced over the past decade.
A standard two-storey home in Montreal rose 120% over the last 10 years while homes in the outlying areas saw an average increase of 107%, the study reported.
In Toronto, a two-storey home within the city rose on average by 89%, while the same home in the suburbs rose by 82%.
The rise was more rapid in Calgary, where the same home rose by 207% within the city and 170% in the suburbs. “Calgary residents have seen boundary expansion in several urban communities, causing a steady increase in average prices during the entire decade, especially in the last 24-month period,” the report said.
See the full Royal LePage’s ‘Urban vs. Suburban’ survey »
Canadian Real Estate Trends
Home Prices Decline for the First Time in Seven Years According to Scotia Economics
After many false calls, there is now convincing evidence that Canada’s housing market has come off the boil, according to the latest Real Estate Trends released today by Scotia Economics. Home resales, having fallen for four consecutive months, are running about 15 per cent below last summer’s historic peak. Average annual home price appreciation has eased back into the mid single digits, as overall market conditions come into better balance. Adjusted for inflation, the average resale home price in Canada registered its first quarterly decline in seven years in the first quarter of 2008.
According to the report, cracks are appearing on the new home front as well. While housing starts in early 2008 are essentially tracking last year’s elevated levels, demand for new residential building permits has fallen sharply. Price increases for new homes are moderating, while inventories of unsold new homes are trending higher.
“We expect overall sales volumes in 2008 to total about 15 per cent below last year’s record levels, and home prices to increase on average by about five per cent,” said Adrienne Warren, Senior Economist, Scotia Economics. “Price gains should slow further in 2009 with the return of a balanced market for the first time in a decade. Meanwhile, housing starts are projected to gradually moderate, returning toward underlying annual household formation levels of around 180,000 by the end of the decade, from the current 225,000 unit range.”
The report also states that the cooling in overall activity is most notable in many of Canada’s hottest urban housing markets in recent years, including Calgary and Edmonton. Both centres have officially moved into buyers’ territory as soaring prices weaken demand and fuel new listings. More generally, however, economic conditions continue to favour the resource-rich markets in the West over manufacturing-dominated centres in Central Canada. Regina and Saskatoon are currently in the strongest sellers’ position nationally, supported by good affordability, rising population inflows and tight supply.
Risk of a major correction still low
According to the report, Canada’s recent record of home price appreciation, averaging an annualized 10 per cent from 2002 to 2007, was unsustainable, and a return to more historical norms is a welcome development. The faster and longer home prices climb, the greater the risk of an eventual price correction. Canada’s last two major housing booms of the 1970s and 1980s were both followed by some degree of real price stagnation or decline, an essential ingredient to restoring affordability and generating renewed pent-up housing demand.
Ms. Warren cites a number of reasons why a major correction is not in the cards, “Home prices in Canada are not substantially overvalued. Our long-term housing price model puts average home prices in 2007 at about eight per cent above their long-term trend, compared with a premium of 12 per cent and 18 per cent, respectively, at the 1976 and 1989 housing cycle peaks. Recent International Monetary Fund (IMF) estimates placed Canada at the bottom rungs of international home price overvaluation.”
Canada’s real estate market is not overbuilt. While inventories of unsold homes are trending higher, the number of unabsorbed units, including condominiums, remains well below prior cyclical peaks in most major centres. Tighter lending guidelines and high construction costs have likely contributed to a more cautious approach among builders.
Households, for their part, are not overleveraged. Home equity as a share of real estate assets is near record highs, with price appreciation outpacing the rise in mortgage obligations. Mortgage carrying costs as a share of disposable incomes are historically low despite rising home prices.
Overall mortgage quality is still sound. Canadian lenders have maintained conservative loan qualifying criteria in recent years even while introducing a range of new products, including interest-only mortgages, no downpayment mortgages, and extended amortization of up to 40 years. Canada does not have ultra-low teaser rate mortgages that have contributed heavily to U.S. defaults as they reset. Adjustable-rate mortgages, sub-prime lending, borrowing against home equity, and insured investor mortgages all account for a much smaller share of the Canadian mortgage market than in the United States.
“At the end of the day, we predict a soft landing for the Canadian housing market, with somewhat lower sales and construction, and a period of relatively flat inflation-adjusted home prices,” added Ms. Warren. “While underlying domestic housing fundamentals remain healthy, a major risk to the outlook would be a deeper and more protracted downturn in the U.S. economy, with more serious repercussions for domestic output, employment and income growth.”
See the full Real Estate Trends report »
Key Real Estate Market Factors
and their effects on Canadian housing
Mortgage Rates
Mortgage rates have moved slightly higher over the past year. This rise, in conjunction with higher house prices, has and will continue to push mortgage carrying costs higher. As a result, this will ease housing demand, particularly for first-time buyers.
Employment
A record share of Canadians continue to be employed, moving the economy close to full-employment. Accordingly, job growth should slow to rates that are more in line with overall population growth. Job creation will continue to stimulate housing demand, but not as much as in the previous years.
Income
Rising incomes will continue because of tight labour markets and a strong demand for workers. This should partially offset the negative impact of higher mortgage carrying costs on home ownership demand.
Net Migration
Net migration is expected to remain strong in 2008. Ontario, Quebec, and British Columbia will continue to attract the bulk of the international immigrants. B.C., Alberta and Saskatchewan will attract a large number of inter-provincial migrants from the rest of Canada.
Demographics
Canada’s population is aging, and as a result, a smaller proportion of people are in their child bearing years and thus the birth rate is decreasing. High immigration levels will slow the average aging of the population, however, the rate of increase in the natural population (births - deaths) is slowing. This will eventually lessen the demand for additional housing stock in the longer term.
Consumer Confidence
Consumer confidence, as measured by the Conference Board of Canada, remains positive. Furthermore, strong consumer sentiment is expected to prevail throughout the forecast period. Confident consumers will continue to support demand for home ownership.
Market Inventories
Lower existing home sales, combined with a high level of new listings in 2008, will move the resale market towards more balanced territory. As a result, the rate of growth in the average MLS® price will moderate during 2008, especially in Canada’s western provinces.
Vacancy Rates
Modest rental construction and increased competition from the condo market will be offset by strong rental demand due to high immigration and a rising gap between the cost of homeownership and renting. As a result, vacancy rates across Canada’s metropolitan centres should remain relatively stable, but slightly higher in 2008.