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The “Why” Behind Expensive Canadian Housing

An article from The Loop

Have we had enough gloomy news about the housing market? Enough is enough. Fixed rate mortgages are up and housing prices are still rising. One day the headlines say the economy is doing well – the next day the economy is slumping and there’s a housing crisis. All this news happens at the same time you’re deciding whether or not to buy a house if you’re a first time buyer, or deciding to list your current home for sale to move up to a larger home. Or should you just stay put until things get better?

The good news is that things are getting better already. There are two key areas of the economy which have a bearing on the housing market – interest rates and jobs. The latest reports are positive for both. Stephen Poloz, the Governor of the Bank of Canada announced last week that the benchmark rate will stay at 1 per cent, at least into 2015. Even more critical is the employment factor because if the economy loses jobs then that erodes a homeowner’s ability to pay their mortgage. Thankfully, that isn’t the case. Statscan’s Labour Force Survey, which is set to be released soon, will likely show steady job growth. All other indicators point to a fairly healthy 2014.

However, there is still the issue of home prices which continue to rise and are a legitimate concern for the government, for economists and ultimately homeowners. After all, the mix of overinflated property values and cheap money were two of the reasons for the U.S. meltdown. That will not happen in Canada and talks of a housing bubble are thankfully in the past. But what about these sky high prices? The Globe and Mail recently analyzed the situation and put it into its historical context. There is little doubt that house prices are inflated. Fitch Ratings suggested that prices are overvalued by 26 per cent in some regions and 21 per cent nationally. The ratings agency also predicted that those prices will fall by 10 per cent of the next five years. But how did we get here? Cheap money! The current low interest rate environment is a direct result of the 2008 global economic crisis – keeping rates low was intended to stabilize the economy. Canada did, indeed, weather the crisis better the most countries (which was awesome!) but eventually we ended up with a bit of a problem.

Low interest rates have created a reality gap as it pertains to affordability and the housing market. It meant consumers could “afford” a more expensive home under the lending guidelines of that time. And up until the last two years, the amortization period could be spread over 40 years, which further lowered monthly payments. This ultimately caused home prices to rise steadily since 2008 as more buyers came into the market. This was not sustainable. Here’s why.

As reported in the Globe and Mail, the average house price in Canada in 1997 was $154,620, which was about 4.9 times the average pretax annual income of $31,484. It’s assumed that house prices rise by the inflation rate every year along with wage increases, which creates “affordability equilibrium in the housing market.” As of July 31, 2013, the average house prices are up to $379,725, which his about 7.8 times the average income of $48,497 – a much wider gap.

What’s worrisome is that wages have not increased in tandem with house prices. Over the past 17 years, house prices have more than doubled wage increases – incomes have risen on average 2.6 per cent while house prices have gone up 5.4 per cent.

So what does that mean to the average consumer and homeowner? Many economists, the government, and think tanks believe that low interest rates cannot be sustained over the long term. If you purchased in the past year or two, at renewal time, you could be facing a large jump in your monthly payment. That home that was once affordable, isn’t so much anymore. (Tip: pay down your debt load and try to pay down your mortgage as much as possible).

As far as housing prices are concerned, the market will likely self-correct. The government has made numerous changes to the lending guidelines and the housing market has felt the effects. There may be one or two more changes coming, which will further tighten the market. If you’re a seller and no one is buying your home at the price listed, then it’s logical to lower the price. And you likely won’t buy another home at an inflated price which will cause sellers to reduce the listed price of other properties … and on it goes until the market finds its own equilibrium.

This, however, may take some time, but it’s already starting. The Canadian Real Estate Association (CREA) reported that resales were down in October for the first time since February. House prices were up 8.5 per cent from a year earlier but take out the hot markets of Calgary, Edmonton and Vancouver, and the prices are up only 4.9 per cent. That’s a good sign that things are moving in the right direction.