Big question is how fast market will adjust to over-valuation
Although one prominent forecaster recently warned that a substantial drop in housing prices is on the horizon, other analysts continue to have a more optimistic outlook.
More likely, the average price in Canada will be about flat for the foreseeable future, says economist Robert Hogue, who follows real estate for the Royal Bank.
Hogue agreed with Craig Alexander, chief economist at the TD Bank, that home prices have outrun income growth for years, bringing a decline of 10 to 15 per cent within the realm of possibility.
But he didn't agree with Alexander that such a drop is probable - or that tough new mortgage-lending rules will be enough to trigger it now.
Economist Adrienne Warren at the Bank of Nova Scotia is also moderately optimistic. New rules that require an insured mortgage to be paid off more quickly will increase mortgage payments, but "I think this will just cool the market faster for first-time buyers," not tip prices into a decline, Warren believes. That's not to say that prices will remain steady across the country. Homes in Vancouver are out of reach for many and those in Toronto seem headed in that direction, making these cities considerably more vulnerable to a fall in values.
But Montreal and most other cities are not significantly over-valued as long as mortgage rates remain low, says Sal Guatieri, an economist at BMO Capital Markets. "What that means is that the market has time to correct," he believes, without the need for a big reversal.
Outside of the two highest-priced markets, Guatieri thinks national home price gains will sputter to a halt over the coming year, then plateau for a few years.
Indeed, most analysts had expected to see prices stabilizing earlier this year. This hasn't happened, perhaps because warm weather and promotional rates on mortgages in the spring stimulated some sales that would otherwise have occurred this summer.
But sales figures for May showed a sales drop in most cities, including Toronto and Vancouver, while the average national price advanced by a moderate 5.2 per cent. True, Toronto sprinted ahead by 7.9 per cent, but Vancouver prices rose by just 3.3 per cent and those in Montreal by 2.2 per cent.
Warren thinks it would likely take a recession to tip prices into a significant decline across Canada. That's not the prediction of most forecasters, who see modest growth continuing.
A more typical pattern in a moderately overvalued market like Canada's, she says, would be "a long period of weak price gains" until rising incomes caught up with steadier home values. In the past, such stagnation has lasted for as much as a decade, she notes.
And even in this scenario, markets in resource-rich areas like Alberta and Saskatchewan could keep seeing gains if commodity markets remain healthy.
It's important to note that the difference between Alexander's prediction of a price drop and other analysts' scenario of stagnant prices is merely a question of how fast prices will adjust, not whether they will.
There's widespread agreement that Alexander's estimate of average overvaluation in Canada is close to the mark - some-where close to 10 or 15 per cent. There's also general agreement that Vancouver and Toronto are the most overvalued markets.
The disagreement is about how the real estate market will react as Canadians approach the limit of their borrowing power - just as new lending rules make a mortgage even more expensive to carry. Both will make the number of eager buyers dwindle.
There's no doubt that in an expensive housing market, prices can fall. But usually, there's a clear cause: Canada's recession brought a one-year slump, while irresponsible lending, speculation and a banking crisis in the U.S. created a much deeper crash that has yet to heal.
But without a powerful prod, homeowners are famously stubborn about avoiding a loss. Many will simply hold off selling if prices are too far below what they expected.
"There's very little pressure on homeowners" apart from the few forced to sell by a transfer or loss of a job, notes Guatieri. So the market normally just stagnates for a while.
But stagnation isn't the same thing as avoiding a loss; it's merely a way of slowing it down. Every year that a home's price rises by less than the rate of inflation, its true value falls a little. Meanwhile, incomes creep up. After a while - maybe a long while - the market returns to balance.
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