Conflicting views on ‘bubble’ emerging

Jim McLeod September 26, 2010

Home prices that continue to inflate even as sales and construction activity fall sparked conflicting views in two new reports Tuesday over whether the Canadian housing market has become a precarious bubble that could burst at any time.

The reports place renewed emphasis on questions that have been simmering since Canada’s housing market appeared to be overheating earlier this year before a major spring slowdown.

Is Canada experiencing a housing bubble?

If so, when will it burst? And, perhaps most troubling for homeowners, will Canadians face a crisis like the one in the U.S?

In the view of the Canadian Centre for Policy Alternatives, prices in six of Canada’s largest housing markets are in bubble territory for the first time in 30 years — and a U.S.-style correction is still not out of the question.

But the C.D. Howe Institute dismissed the possibility in its own report, which concluded that Canada’s cautious mortgage lending policies will protect against a housing crash similar to the one that has hammered the market in the United States.

Bubbles generally occur when housing prices rise faster than inflation, incomes and economic growth, until they reach unsustainable levels and a collapse in prices is triggered.

Many of the concerns about the Canadian housing market are motivated by the recent experience in the U.S., where one in 10 homeowners faces foreclosure.

But there is little likelihood of a surge in foreclosures or a collapse of house prices in Canada, according to the C.D. Howe report.

That’s because of the country’s tighter mortgage requirements — which include a minimum down payment of five per cent, as opposed to zero down at some U.S. banks — as well as regulations against risky lending and a much smaller subprime mortgage market, the C.D. Howe report says.

U.S. home prices fell about 30 per cent between 2006 and 2009, while Canadian prices fell only about nine per cent before a rapid bounceback last year.

Canadian homes are now estimated to be overvalued by as much as 15 to 20 per cent.

The CMHC predicts average prices in the third quarter of this year will be $336,400, a 2.4 per cent decline from an April peak of over $344,000.

The Canadian Centre for Policy Alternatives report says the steep rise in house prices — which now sit at 4.7 to 11.3 times Canadians’ annual income in many cities — is an “accident waiting to happen.”

It would take only a one to 1.25 per cent mortgage rate increase by Canada’s big banks to cause a housing crash similar to the one the U.S. is grappling with, said David Macdonald, author of the report.

However, many economists have concluded that Canada’s once-overheating housing market, which began to cool in the second quarter of the year, has stopped just shy of a bubble.

Adrienne Warren, a real estate economist at Scotiabank, said overvaluation in the Canadian market is largely due to underlying supply and demand conditions that have driven prices up, and not the type of speculative activity normally associated with a housing bubble.

“Given the strength of demand, there was a shortage of choice out there and that led to essentially sellers’ market conditions throughout the decade. It’s something that is fairly unprecedented,” Warren said.

She maintained that Canada’s housing market will avoid a sharp correction, and will instead continue to see a gradual softening in prices.

“A trigger for a sharp correction would be signs of overbuilding … or a recession and a sharp rise in unemployment rates,” she said.

“That’s not the typical scenario we see unfolding for the next few years.”

Bob Dugan, chief economist at the Canada Mortgage and Housing Corporation, said new housing starts are expected to moderate in the second half of this year and stabilize in 2011 as they adjust to lower demand, which should further deflate fears of a bubble.

He pointed out that while prices have risen rapidly from a trough at the end of 2008, they have increased by a more moderate 2.1 per cent over the 31-month period beginning with a pre-recession peak of $325,000 at the end of 2007 to around $332,000 in July.

Dugan said home prices are expected to gradually decrease, and there isn’t a lot of evidence to support the fact that Canada is experiencing a house-price bubble.

The CMHC predicts average prices in the third quarter of this year will be $336,400, a 2.4 per cent decline from an April peak of over $344,000, Dugan said.

“I don’t think it has to do with a bursting bubble. It has to do with the fact that … we’re seeing a different balance between supply and demand.”

Extract of the Red Deer Advocate

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