Canadian House Prices-A Bubble or Not?

Every Saturday, the Toronto Globe and Mail’s Report on Business section publishes a table of Major City House Price Changes, with one week being the percentage change for the 5 biggest and smallest changes in individual cities in Canada over 1 year, and the next week being the change over 5 years. There has been much debate in Canada, and from outside observers, as to whether the Canadian housing market was overvalued, and whether, as in the case of the US, the UK, Ireland and Spain in particular, a bubble was forming in the property market. Pessimists pointed to the high level of house prices to average wages, and the high level of household indebtedness in Canada, which is now higher than the US and the UK. Furthermore, having experienced a 2 year decline between 2008 and early this year, which in some of the hotter markets such as Vancouver, Calgary and Edmonton, had seen falls of 20% or more, prices nationally have recovered, and for the country as a whole, taking the National Bank/Teranet Index of house prices, prices were up 12% in the 12 months to August, 2010.

Optimists focus on the differences between the US and European markets and Canada, including but not limited to the much better mortgage underwriting practices of the Big 5 Canadian banks, including verifying borrowers’ incomes and the requirements imposed by the Canada Mortgage and Housing Corporation (CMHC), the 100% government owned mortgage insurer, which requires a 5% downpayment to insure a mortgage, and reduced the maximum term of insurable morgages to 35 years in 2008. In Canada, the lender has recourse to all of the borrower’s assets, not merely the house itself, as is the case in 46 of the 50 states in the US, making it much more difficult for borrowers to walk away from underwater mortgages, and there is no tax deductability for mortgage interest, unlike the US. Lastly, the CMHC stands ready to purchase any eligible mortgage from the banks, so the C$400 billion or so of mortgage assets on the banks’ books are in effect liquid government debt, and the government actually bought billions of mortgages from the banks in late 2008 and early 2009 to ease any liquidity problems.

Lastly, and perhaps most importantly, the Canadian economy is in much better shape than the US and western Europe, owing to its large resource exposure, and its conservatively run banking system not needing to be bailed out by the government, both reducing the size of the government’s deficit, and making the banks willing to continue lending, albeit in a somewhat more conservative fashion. Looking at the 5 year changes in major city house prices as of November 2010, the Canadian national average house price is up 34.1%, a situation very different from that of the US, UK, Ireland or Spain. Amongst the 5 cities with the largest increases in price, all of them are western cities with exposure to the boom in resources, with the Saskatchewan pair of Saskatoon and Regina up 110% and 91% respectively, nickel town Sudbury up 63% and Winnipeg in Manitoba and Edmonton in Alberta up 62% and 60%. Of the 5 cities that have the lowest increase in prices over the last 5 years, the common theme is exposure to sectors dependent upon the US domestic economy. Thus Windsor, opposite Detroit, St Catherine’s in the Niagara peninsula and ¬†Durham, which includes the GM plant in Oshawa, just east of Toronto,¬†are up only 6%, 17% and 18% respectively, while forest products-dependent Thunder Bay in western Ontario is up a mere 7%. The other laggard, however, may surprise; it is Canada’s largest city, Toronto, with a 29.5% increase since 2005. To a certain extent, this reflects the importance of the auto industry to the economy of southern Ontario, with the Ford plant at Oakville and the Chrysler plant at Brampton, both western suburbs of Toronto, suffering along with GM from the downturn in demand for autos in the US. An unbiased observer would probably feel that house prices barely keeping ahead of inflation in a country’s largest city would not indicate that a bubble was fully formed, even though the price to average wages level was certainly high compared to historical levels. With 5 year fixed rate mortages going for 3.44%, the present level of house prices seems sustainable in the absence of sharp increases in interest rates, up 0.75% to a still very low 1% in the last 6 months. Likewise unemployment, which has fallen below 8% as the 400,000 jobs lost in the recession have all been regained, does not seem to pose a major threat at the moment.

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