|Housing bubble or prudent investment?|
Jay Bryan Postmedia News
Some analysts argue that the housing market is way overpriced. But, a study by the National Bank suggests otherwise and that a crash is awfully unlikely, Jay Bryan reports
One of the dirty little secrets of financial analysis is that you can "prove" that the very same asset is either expensive or cheap, simply by choosing different yardsticks to measure it.
In the debate over Canada's supposed housing bubble, you can make housing look expensive by looking at how home prices compare with annual incomes or with rents. In both cases, these ratios are now above their long-term averages, suggesting housing is expensive.
But you can also make home prices look cheap by comparing today's average mortgage payment with those of past years. In this case, homes look cheaper than in the past.
There's room for debate over which yardstick makes the most sense, since each has its virtues. The answer: it depends where you think interest rates are going.
Matthieu Arseneau, a senior economist with the National Bank, likes mortgage payments as the best yardstick. That's because the evidence tells him that the rise of interest rates from today's bargain-basement levels will be moderate. Based on this, he thinks it's silly to foresee a housing crash, since monthly payments won't get into distress territory even by the time rates peak in about three years.
That's why Arseneau dismisses apocalyptic talk about a housing crash in Canada. As a cautious analyst, he doesn't rule out any scenario absolutely, but Arseneau said Monday that this one is awfully unlikely: "I think there will be no collapse unless there's a worldwide recession and credit crisis."
Still, those who choose to base their measure on home prices could argue that with interest rates at historic lows, mortgage payments are artificially depressed.
Therefore, they would say, you should ignore the impact of cheap money, since it will inevitably become more expensive.
This is true, but probably irrelevant.
Why? First, because everything depends on how fast and far rates go.
And second, even the absolute level of price over-valuation is pretty modest. Different analysts agree that the International Monetary Fund's estimate of about 10 per cent is close to the mark.
That's small enough that just a few years' price stagnation would be enough to wipe it out, since incomes are constantly rising.
And this, in fact, is the scenario predicted by both of the two recent bank analyses of the real estate market, one by BMO Capital Markets and the other from Arseneau.
Arseneau notes that our experience has been just about the opposite of the U.S., with home prices in Canada up 13.1 per cent from their pre-recession peak while those south of the border remain down by 33.5 per cent.
Comparing Canada with 20 other rich industrial countries monitored by the Organization for Economic Co-operation and Development, he finds that we're one of the 10 countries where prices are up over the past four years, with bigger gains than any other country except Israel.
This outperformance by Canada is a key part of the argument offered by those who fear an impending crash. When you soar this high, you have to fall back, they reason.
But that argument is flawed. It leaves out some essential factors.
First, Canada's job creation over this period (up 3.1 per cent compared with shrinkage of 3.5 per cent in the U.S.), places us well ahead of most industrial nations.
This means that more and more people here have the income to buy homes.
Second, Canada's growth in the home-buying population is much stronger than average in this group of nations.
Between 2010 and 2015, the key demographic group for first-time home-buying, 20-to-44-year-olds, will grow by 4.2 per cent in Canada.
That compares with second-place growth of 3.6 per cent in the U.S. and shrinkage of between 1.7 and 8.7 per cent in Japan and the five biggest European countries.
Most important, interest rates in Canada have stayed exceptionally low for a country that suffered a short, mild recession.
But even so, Arseneau doesn't believe this caused Canadians to borrow imprudently.
Indeed, after measuring the extra borrowing capacity the low rates opened up, he notes that Canadians "are playing it safe" by leaving a lot of this potential untapped.
Homebuyers acted as if they were perfectly aware that rates would eventually rise, Arseneau said: "I think they are better informed than some analysts think."
A mortgage on an average-priced home now costs 28.7 per cent of average take-home pay, or a little less than the 15-year average of 28.9 and far below the 35.1 per cent recorded just before the recession in 2007.
If five-year mortgage rates climb by about 2.5 percentage points through the end of 2014, which is about the maximum that the National Bank's forecast for bond markets would lead one to conclude, the average mortgage payment will still consume only about 32 per cent of income.
This does assume, however, that home prices now plateau, an assumption shared by some other analysts. If price gains were to speed up, though, there is a danger that the market could become increasingly risky.
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