Canada’s real estate market trends

Home Prices Decline for the First Time in Seven Years According to Scotia Economics

After many false calls, there is now convincing evidence that Canada’s housing market has come off the boil, according to the latest Real Estate Trends released today by Scotia Economics. Home resales, having fallen for four consecutive months, are running about 15 per cent below last summer’s historic peak. Average annual home price appreciation has eased back into the mid single digits, as overall market conditions come into better balance. Adjusted for inflation, the average resale home price in Canada registered its first quarterly decline in seven years in the first quarter of 2008.

According to the report, cracks are appearing on the new home front as well. While housing starts in early 2008 are essentially tracking last year’s elevated levels, demand for new residential building permits has fallen sharply. Price increases for new homes are moderating, while inventories of unsold new homes are trending higher.

“We expect overall sales volumes in 2008 to total about 15 per cent below last year’s record levels, and home prices to increase on average by about five per cent,” said Adrienne Warren, Senior Economist, Scotia Economics. “Price gains should slow further in 2009 with the return of a balanced market for the first time in a decade. Meanwhile, housing starts are projected to gradually moderate, returning toward underlying annual household formation levels of around 180,000 by the end of the decade, from the current 225,000 unit range.”

The report also states that the cooling in overall activity is most notable in many of Canada’s hottest urban housing markets in recent years, including Calgary and Edmonton. Both centres have officially moved into buyers’ territory as soaring prices weaken demand and fuel new listings. More generally, however, economic conditions continue to favour the resource-rich markets in the West over manufacturing-dominated centres in Central Canada. Regina and Saskatoon are currently in the strongest sellers’ position nationally, supported by good affordability, rising population inflows and tight supply.

Risk of a major correction still low

According to the report, Canada’s recent record of home price appreciation, averaging an annualized 10 per cent from 2002 to 2007, was unsustainable, and a return to more historical norms is a welcome development. The faster and longer home prices climb, the greater the risk of an eventual price correction. Canada’s last two major housing booms of the 1970s and 1980s were both followed by some degree of real price stagnation or decline, an essential ingredient to restoring affordability and generating renewed pent-up housing demand.

Ms. Warren cites a number of reasons why a major correction is not in the cards, “Home prices in Canada are not substantially overvalued. Our long-term housing price model puts average home prices in 2007 at about eight per cent above their long-term trend, compared with a premium of 12 per cent and 18 per cent, respectively, at the 1976 and 1989 housing cycle peaks. Recent International Monetary Fund (IMF) estimates placed Canada at the bottom rungs of international home price overvaluation.”

Canada’s real estate market is not overbuilt. While inventories of unsold homes are trending higher, the number of unabsorbed units, including condominiums, remains well below prior cyclical peaks in most major centres. Tighter lending guidelines and high construction costs have likely contributed to a more cautious approach among builders.

Households, for their part, are not overleveraged. Home equity as a share of real estate assets is near record highs, with price appreciation outpacing the rise in mortgage obligations. Mortgage carrying costs as a share of disposable incomes are historically low despite rising home prices.

Overall mortgage quality is still sound. Canadian lenders have maintained conservative loan qualifying criteria in recent years even while introducing a range of new products, including interest-only mortgages, no downpayment mortgages, and extended amortization of up to 40 years. Canada does not have ultra-low teaser rate mortgages that have contributed heavily to U.S. defaults as they reset. Adjustable-rate mortgages, sub-prime lending, borrowing against home equity, and insured investor mortgages all account for a much smaller share of the Canadian mortgage market than in the United States.

“At the end of the day, we predict a soft landing for the Canadian housing market, with somewhat lower sales and construction, and a period of relatively flat inflation-adjusted home prices,” added Ms. Warren. “While underlying domestic housing fundamentals remain healthy, a major risk to the outlook would be a deeper and more protracted downturn in the U.S. economy, with more serious repercussions for domestic output, employment and income growth.”

See the full Real Estate Trends report »