With only Montreal and Vancouver left to cheer for in the Stanley Cup playoffs, many luncheon conversations have returned to the topic of housing prices.
Recently, we've seen lots of headlines suggesting that house prices have run up to an unsustainable level and are due for a correction.
In mid March, The New York Times made a rare foray north of the border with a headline that read "Some See a Real Estate Bubble Forming in Canada." A couple of weeks back, Gluskin Sheff star economist David Rosenberg released a report suggesting that Toronto and Vancouver housing prices could drop by 20 per cent.
And one of the most e-mailed Globe articles last week was based on a ReMax report trumpeting the buoyant sales of luxury homes.
Focusing on affordability
Perhaps the most important determinant of short-term-price movements is affordability, the percentage of a typical household's income required to carry a house. The two big variables that drive this number: house prices and mortgage rates.
RBC has been tracking this data for 100 neighbourhoods across Canada since 1985, focusing on typical two bedroom homes, bungalows, townhouses and condos.
The traditional rule of thumb for banks is that mortgage payments, property taxes and utilities shouldn't exceed 32 per cent of a household's income, assuming a 25 per cent down payment. The more of a household's income required to carry a house, the lower the affordability.
As housing prices spiralled up in the 1980s, this guideline was relaxed - since 1985, the typical household would have devoted 39 per cent of its income to carrying a detached, 1,200 square foot bungalow.
RBC economist Robert Hogue points out that there have been large swings in affordability over time and that different cities show different patterns.
In most cities, rising house prices meant that affordability was at its lowest in early 1990, when the typical household would have spent 53 per cent of income to carry a bungalow. On the other end of the scale, Vancouver, always an outlier when it comes to real estate, hit its own high of 81 per cent of household income to carry a bungalow in early 2008.
Once out of balance, there are only three ways for affordability to get back in line:
- Prices can stay flat as incomes increase over a period of years
- Mortgage rates can come down - unlikely in the next while
- Or housing prices can drop - something that happened after the all-time lows on affordability were hit in 1990
The impact of low mortgage rates
In the past eighteen months, governments around the world chopped interest rates to boost economies - and Canada was no exception.
As a result of low interest rates, carrying costs dropped and affordability improved. Even with strong housing prices, at the end of December the affordability level in most cities was close to its long-term average. The exception, again, was Vancouver - with the average bungalow taking up 69 per cent of the typical family's income, up from the historical average of 57 per cent.
In a recent report, RBC estimated that in late December posted rates for a five year mortgage were 5.6 per cent, 1.6 percentage points lower than normally expected given inflation expectations. Note that we've already seen mortgages rates begin moving up toward those higher levels, with more increases likely to come.
RBC estimates that if mortgages had been at their normal levels in December, the percentage of the typical Canadian household's income to carry an average bungalow would have increased by four percentage points - although some cities would have been hit worse than others.
The affordability verdict
If mortgage rates in December had been at normal levels, the percentage of income to carry a house in most cities would have been well above its long-term average. The good news: In most cities those percentages would still have been well below their highs - prices may be a bit elevated but this doesn't suggest a bubble or a big drop ahead.
The one city to worry about if you're a homeowner is Vancouver, where normal mortgage rates would have resulted in the typical household spending 78 per cent of its income to carry a bungalow, just shy of the peak level.
History shows that it's impossible to accurately predict short-term movements of house prices - markets regularly overshoot rational levels both on the way up and the way down. What we can say is that based on current affordability, if house prices do continue to escalate, at some point they're almost certain to correct back down.
That means there's no rush to buy and time to wait for the right home at the right price - and that for the next while at least home buyers should evaluate houses as places to live rather than on their potential for appreciation.