For all the hand-wringing about a housing bubble, domestic real estate prices aren't going up that fast. Taking inflation into account, growth in the Teranet Housing Price Index is bumping along in a range far below the pre-financial crisis period, when interest rates were much higher.
Has a grinding correction in the Canadian housing market already begun?
The chart below compares year-over-year growth in domestic retail spending against the inflation-adjusted year-over-year growth in Canadian housing prices. My assumption is that a significant slowdown in consumer spending would occur before we see a major crack in the housing market. When mortgage payments begin to truly bite, households will pull back on spending long before they stop making mortgage payments.
SOURCE: Scott Barlow/Bloomberg
Retail sales did provide a warning of slowing housing price growth in July 2006 and September 2011. The most recent retail sales data, however, suggests there's no real reason to be concerned about a big dip in housing prices.
The chart also underscrores the much slower year-over-year growth in domestic home prices relative to the period from 2000 to 2006. Then, the average Canadian home price climbed steadily by five to seven per cent per year, after inflation. In the past three years, average price growth has fallen to 2.7 per cent.
There is no doubt that rising housing costs have stretched Canadian household balance sheets – debt to disposable income ratios started setting records a long time ago. There are pockets of apparent excess where real estate prices look unsustainably stretched – Vancouver and the Toronto condo markets are the most obvious examples. A sharp rise in interest rates would undoubtedly cause corrections in these markets and others.
But 30-year government bond markets (which reflect longer-term interest rate expectations) continue to suggest that, while short term rates may rise a bit, "lower for longer" is the likely course for mortgage rates in the years ahead. If accurate, this forecast implies more of a slow, grinding correction in the housing market – one that may already be underway.
Over the an extended period, an inflation-adjusted zero to two per cent growth rate in housing prices, combined with reasonable GDP and population growth, would constitute a relatively pain-free correction in the domestic housing market. In essence, living costs would be treading water while the fundamentals (economic growth and demand primarily) would be improving. This would be similar to a high price-to-earnings stock where the price didn't move, but earnings growth eventually made the stock's P/E ratio attractive.
This is a rosy scenario, I admit, and there are any number of economic occurrences that could get in its way. More weakness in oil prices could cause a quick drop in Alberta home prices, for example. Even so, I find the possibility of a grinding, long term adjustment in the Canadian real estate entirely plausible.
Follow Scott Barlow on Twitter @SBarlow_ROB.