|Bear snarls at housing|
Jan 5, 2010 Finn Poschmann Financial Post
It was a good run. And now, in 2012, it is time for Canada's housing market to stop running and catch its breath.
Three things have pushed me, growling and snarling, into the bearish camp. First is the seemingly relentless upward march in housing prices, which eventually will stop rising faster than incomes. Second is household debt, which has reached great peaks and will surely begin to wobble. Third is the heady share of domestic output that is being absorbed by housing construction, displacing arguably more productive investment elsewhere, which it cannot forever continue to do.
The arithmetic is simple, and some of the warning signals look uncomfortably like those of the days before the market implosion that brought the 1980s to a thumping, crashing close.
Start with resale home prices. A "matched sales" approach to measuring prices tracks, over time, multiple sales of the same properties - this reduces the likelihood of measurements getting skewed by cyclical or regional shifts in the price mixes of homes that happen to be selling. Over the past 10 years, prices so measured, in Canada's major markets, have doubled, increasing at more than 7% per year, at a time when consumer price inflation generally had been running at about 2%.
So why is that a problem? Because average wages have not been running much ahead of inflation, and that means that house prices have steadily been bubbling out of reach of workers' abilities to afford them. The house price-to-income ratio last peaked and then plummeted from 1989 to 1991, and the ratio regained its prior peak in 2004-05. Since then? It has climbed steadily higher yet, the ratio now far outstripping anything seen in the past 20 years.
Eventually that makes housing affordability a problem, and quickly so when interest rates start to rise. Housing looks affordable now, given that mortgages remain on the market at rates near their alltime lows. However, carrying costs relative to income would rocket upward, were rates one or two percentage points higher. Such rate increases are not in the cards in Canada today - but they will arrive all the same, and sooner rather than later if inflation continues to test the upper bound of its target range, as it did through 2011.
Of course, a household's ability to carry mortgage debt depends on how much debt it has in total, relative to income, and relative to assets. Canadians have got used to hearing alarms about rising debt levels relative to household incomes, but may not have picked up on how remarkable and persistent is the phenomenon. Debt, especially consumer credit, started rising in the 1990s - in the U.S., however, the trend reversed course in the last half of the last decade. Not so in Canada, where consumer credit relative to income has marched as steeply upward, since 2005, as it had done over the prior five years. Over the past decade, mortgage debt has grown at 8% and consumer credit at an average 9% annually.
Of course, this would matter less if the rise in debt was matched by rising household assets - and make no mistake, household net worth has been growing decently well. However, household debt relative to assets took a big upward knock in 2007-08, and the reason is not just the rise in debt, but a shock to the value of household financial assets. Over the past decade, financial assets have grown at about 5% per year. Accordingly, household debt - mortgages plus consumer credit - relative to the market value of financial assets, has recently been sitting at a higher ratio than it has at any point in the past 20 years. Taken together, the implication is that a significant portion of the run-up in Canadian housing prices has been driven by credit availability, and that the pattern has increased household vulnerability to financial shocks.
These data cast doubt on the continuing ability of Canadian families to devote rising shares of their incomes to buying housing. That means the pace of demand will slow.
What about supply of new residential housing stock? That too must slow. Nationwide, residential housing investment is soaking up about 7% of annual output, and it has done so since early 2007. A more normal share would be 5% or 6% of output and, while that difference might seem small, over time it adds up to a lot of overbuilding. Tangibly, such overbuilding might look like a forest of condo towers, a forest where the number of finished but unoccupied units begins quietly to grow, then suddenly to look like a glut.
So: housing prices have for many years been rising faster than Canadians' incomes, and those households' abilities to take on new debt to afford that housing will eventually be tapped out. Meanwhile, the pace of investment in new housing construction has been persistently and uncomfortably high, and the dark spectre of forests of less-than-full condo towers begins to loom.
This view is consistent with three market outlooks, the first being that house price appreciation will thoroughly stall out; this is the brightest view. Next is the likelihood of what housing market forecasters might call a market correction, a price drop of 5% to 10%. The third possibility, which becomes more likely in the event of a significant hit to labour markets, is a bursting bubble, a bigger average price drop, and a lot more households financially underwater.
No aspect of the data supports a bullish view of housing markets. Sound monetary policy from the government and the Bank of Canada aimed at hitting the 2% annual inflation target, and that does not encourage household debt accumulation, and does not seek to prick any bubbles, would be supportive of either of the two relatively benign outcomes. A burst bubble need not be in the cards for Canada. But it would be hard to avoid in the event of a flagging global economy and its inevitably nasty impacts on local labour markets.
All in all, a safer time to be a bear.
- Finn Poschmann is vice-president, research, at the C.D. Howe Institute in Toronto.
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