October 10th - 2010

Bubble or no bubble? Two studies show conflicting opinions

Is the Canadian real estate market in a bubble about to burst or not?

Is the Canadian real estate market in a bubble about to burst or not? Two separate reports, by two non-partisan, non-profit, economic research organizations -- The C.D. Howe Institute and the Canadian Centre for Policy Alternatives (CCPA) – paint two different pictures of the Canadian economic situation. While CCPA says yes, many of our major markets are in a bubble, C.D. Howe maintains that as long as Canada’s fiscal policies and mortgage underwriting standards remain conservative, our economy will not experience the devastation happening in the U.S. and elsewhere in the world.

Here’s a summary of the two reports:

Bubble

For the first time in 30 years, a synchronized housing bubble has spread to six red-hot real estate markets in Canada, says a report by the Canadian Centre for Policy Alternatives (CCPA).

Canada’s Housing Bubble: An Accident Waiting to Happen examines trends in house prices in Toronto, Vancouver, Calgary, Edmonton, Montreal and Ottawa between 1980 and 2010 and finds price increases in those cities are outside of a historic comfort level.

On average, inflation-adjusted house prices in these cities have historically held stable at between $150,000 and $220,000 in today’s dollars, but current housing prices in all six major markets are now over $300,000, on average.

Historical trends indicate Canada’s hottest six real estate markets are more unstable than a generation ago, especially after steep house price increases between 2002-07. Before 2000, house prices tended to hover within a narrow range of between 3 and 4 times provincial annual median income. Today, house prices are anywhere from 4.7 to 11.3 times the median income.

As house prices rise outside of their historical range they become much more susceptible to mortgage rate changes. The hottest six real estate markets could be in for a correction at best or, at worst, a bubble burst. Rate setters at the big banks are in the driver’s seat now as mortgage rates inch up. They need to hit the brakes lightly.

Canada has only had three housing bubbles burst, twice in Vancouver and once in Toronto. The study simulates the conditions of the two most recent bubbles, as well as the 2006 housing market collapse in the U.S., to assess how bad a correction might be. It predicts homeowners in Edmonton and Montreal could be hardest hit, losing 38% to 34% respectively of their property value in under three years in a worst-case scenario. Vancouverites would be worst hit, in dollar value, losing almost $200,000. 

No Bubble

The CD Howe Institute says: Recent swings in Canadian house prices have raised concerns that a US-style housing bust looms on the horizon. A comparison of housing market policies in Canada versus the US, however, suggests that there is little likelihood of a US-style surge in foreclosures or a collapse of house prices in Canada.

Many of the concerns about the Canadian housing market are motivated by recent US experiences. Over the years 2000 to 2006, US prices appreciated nearly twice as much as Canadian house prices. This rapid appreciation has been followed by an equally rapid decline, as US house prices declined by over 30 percent between 2006 and 2009, before staging a modest recovery late in 2009, only to fall into the doldrums again this year.

The decline in Canadian house prices lagged the US, and was more muted, as house prices continued to appreciate until late 2008, before declining by roughly 9 percent between August 2008 and April 2009. This decline was followed by a rapid bounce back, with house prices returning to their pre-recession high by the end of 2009. After another price surge in the spring of this year, buyers and sellers remain on tenterhooks about the future path of prices.

Canadian housing policies, which avoided the sharp decline in underwriting standards seen in the US, worked well in reducing the possibility of a housing bust in Canada during 2008-2009, and continue to mitigate the risk of a massive wave of defaults in the future. To the extent that current policies impose on taxpayers a significant exposure to mortgage insurance guarantees and, therefore, some of the aggregate risk of a decline in housing prices, it will be in the interest of all Canadians if policymakers recall the lessons of the 2008-2009 experience should pressures to relax underwriting standards reoccur in the future.

For more information visit www.cdhowe.org and www.policyalternatives.ca.

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Jean-Adrien Delicano

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