Saturday, November 21, 2009 5:59 PM
Why home prices are frothy
Andrew Willis
In what amounts to a battle of real estate agency versus economists, Scotia Capital is out to prove that the Canadian housing market is frothy, and runs the risk of overheating.
At a time when agents are enticing home buyers with claims that “affordeability” has rarely been better, Scotia Capital economists Derek Holt and Karen Cordes put out a report Friday that shows this is just one measure of a market that now features “lofty” valuations on residential real estate.
Affordability measures the cost of owning a home – mortgage payments, utilities and property taxes – against personal income. By this measure, the cost of home ownership has been dropping steadily since 2007. A recent report from Royal Bank of Canada showed this index has been moving home-owners way for five consecutive quarters, and “at the national level, affordability has now been restored to pre-housing boom levels, that is, those prevailing in late 2005-early 2006.”
Partly as a result of perceived affordability, home sales are soaring, and prices in Canada's resale housing market are up 12 per cent on a weighted average basis from last year, according to Canadian Real Estate Association figures released last week.
The problem with the affordiability index is it reflects interest rates, and mortgage rates, that are at or near historic lows. When rates rise, the cost of home ownership will soar.
“Our least favourite measure for current purposes is an affordability measure that compares payments to income,” said Scotia Capital. The economists point out that this scale does not address the fair value of a home, which counts as most Canadians single most valuable asset.
Instead, Scotia Capital looked at other common-sense ways of putting real estate prices in perspective.
For starters, the investment bank looked the the ratio of home prices to rental rates, and found it is at an all-time high.
The economists compared house prices to income, and again found the ratio was high, which means valuations are heady. Finally, they looked at the supply of homes for sale. With the exception of the condo market, which is awash in properties, there is a relatively tight supply of homes, and robust demand.
“Canadian house prices are rich no matter how one looks at it, but they are likely to become richer yet before material risks emerge later next year and beyond,” said Scotia Capital’s economists. But Mr. Holt and Ms. Cordes added: “Flagging rich valuations is not, however, tantamount to predicting anything imminent by way of give back on prices. In fact, they could well push further into record territory next year, before material risks build.”
