Canada's Housing Bubble

Sales rocket as central bank warns citizens to plan for higher rates, but some analysts are still upbeat

December 18, 2009 Reuters gulfnews.com

Toronto : A red-hot housing market fuelled by cheap money has helped Canada climb out of recession, but fears are growing that it could be a bubble much like the one that brought the US to its knees.

Household debt is climbing as buyers use record low rates to stretch for previously unaffordable homes in markets like Toronto and Vancouver, where prices hit record highs. Sales have gone through the roof and bidding wars are common.

Yet even as the central bank warns Canadians to plan for higher rates, analysts say factors including housing supply, demographics and lending practices make a US-style crash unlikely.

"I don't think we're in a bubble. What we're seeing is a monetary policy that is working very efficiently," said Benjamin Tal, senior economist at Canadian Imperial Bank of Commerce.

"There is a bit of overexposure, yes ... but a more reasonable scenario is it's a redistribution of activity — namely, what we are doing now is stealing activity from the future," he said. "There is almost an urgency to buy a house right now."

The market's dynamism was highlighted by a report on Tuesday that showed existing home sales jumped 73 per cent in November from a year earlier, while the average price rose 19 per cent nationally.

There is no doubt that housing prices in some Canadian markets are rising quickly, and that more homes have changed hands this year than even when the market was at its peak in 2007.

But many analysts are wary about calling it a bubble, which would imply that home values have increased too fast to unsustainable levels relative to incomes and other economic elements.

Supply constrained

"Once we're through February, when the traditional sales cycle begins in Canadian real estate, we'll see much more interest in listing homes for sale. The demand side has been here since the second quarter of this year, but the supply side has been constrained," said Phil Soper, president and chief executive of Royal LePage Real Estate Services.

"We're still going to see a high number of transactions, and in fact we'll probably see even increased levels of transactions over this year, but I don't think price will follow."

The Canadian market slumped during the recession but escaped a US-style meltdown. In some regions demand and prices merely eased from soaring heights seen before the downturn.

Underpinning the market are record-low interest rates, which mean variable mortgages can be found for nearly as low as 2 per cent.

As in the US, when the recession hit, central bank policy-makers dropped interest rates near zero in a bid to get consumers spending again. The Bank of Canada added a conditional promise to freeze rates until at least mid-2010. Americans have remained cautious as unemployment rises. Canadians have bounced back more quickly. In Canada, confidence is just 10 per cent below what it was in 2007, and employment has started to rise again.

While sellers held off putting their houses on the market early in the year, fearing the recession, buyers were eager to jump at the cheap money. With more buyers than sellers, prices started to climb and talk of a bubble took off.

Policymakers have taken note. The Bank of Canada warned last week that the buying frenzy is boosting the potential for over-leveraged households. High levels of household debt, it said, pose the biggest threat to economic recovery.

Stewart Hall, an economist at HSBC Canada, says there are signs the cheap money may be too much of a good thing.

‘Response'

"When you look at what's going on in the housing market against the backdrop of both policy measures and monetary measures, it gives you some sense that you are indeed seeing a response — something that is going on here beyond what we consider the burning off of pent-up demand," said Hall.

The impact of low interest rates on what a family can afford in housing is dramatic. A family that wants to put 5 per cent down and spend C$2,000 (Dh6,8437) a month on a mortgage can buy a C$550,000 home when rates are at 2 per cent. When rates rise to 6 per cent, a family with the same budget can afford only a C$350,000 house.

That's the difference between a three-bedroom on the Toronto subway line and a two-bedroom on the wrong side of the tracks. Why wait? Buy now.

Both sales and prices are expected to remain supported by this heady cocktail of pent-up demand, low supply, and the central bank's rate promise.