Every dollar that house prices rise undermines the argument that buying a home today is a great investment.
The latest numbers out of the Toronto market seem to suggest otherwise. Sales were up 23.5 per cent in August and the average price was up 17.7 per cent. A year ago, the city was coming off a year-over-year price gain of 10.3 per cent. Can this possibly continue?
Prices in Toronto and elsewhere may keep rising from current levels, but the outlook is uncertain because it depends on both real estate fundamentals and the potential for government action to cool the market. What we do know is that people buying houses today are getting into a very expensive market in some cities. Buying low is the foundation of smart investing. In housing right now, you're buying high.
The motivation for buying a home has always been a mix of practicality (you have kids, you need space), lifestyle (you want to personalize your living space), freedom (you want to own your living space) and financial gain. But the prospect of making money seems a bigger influence on home buying today.
One way to assess the cost of housing is to compare home prices to gains in income. Data from Statistics Canada show median total family income has risen an estimated 59 per cent in total since 2000 without adjusting for inflation. National average resale house prices have increased by a cumulative 192 per cent over the same period.
A lot of this disparity is fuelled by the Vancouver market, where prices rose 240 per cent and incomes increased 56 per cent, and Toronto, where incomes rose 40 per cent and home prices increased 192 per cent. Less dramatic mismatches can be seen in Calgary and Halifax, where income growth was a little less than half the rate at which house prices increased on a cumulative basis.
We slept through this massive repricing of houses because falling interest rates kept things quiet. Rates have a more powerful impact on affordability than prices. But housing is still less affordable than it used to be, most notably in cities like Toronto and Vancouver.
A discounted five-year fixed mortgage might have gone for 7.25 per cent in 2000, which means monthly payments of $1,605 per month if you made a 10-per-cent down payment on a Toronto home priced at the average $243,249. In mid-2016, the comparable monthly payment was $2,930. That's based on a mortgage of 2.25 per cent, a home costing $709,825 and a 10-per-cent down payment.
The annual cost of this mortgage would be $35,160, or 45 per cent of the median Toronto family income. In 2000, the annual mortgage cost in our example would have been $19,260. That's 35 per cent of the median family income back then.
The point here isn't that houses are definitively unaffordable. Even as banks tighten lending out of concern about an overpriced market, there are enough qualified buyers. But house prices have already soared in value, which means the chances of a big investment gain if you buy today depends on more price appreciation to come.
The two biggest risks for housing are higher interest rates and rising unemployment. Neither seem imminent in today's so-so economy – it's not hot enough to generate inflation and higher rates, and neither is it weak enough to cause a spike higher in joblessness. But that doesn't mean housing is cleared for more gains ahead.
Sales tanked in Vancouver last month because of a new tax on foreign buyers. Concerns that foreign buyers would migrate to Toronto may have been validated by the city's stellar August numbers. That means rising pressure to introduce a foreign buyers tax in Toronto as well. Don't forget that the federal government has also been looking at the health of the housing market, particularly Toronto and Vancouver.
The question of whether housing prices can keep rising is wide open to analysis. But we know for certain that housing today is expensive. Remember that if your rationale for buying is based in large part on houses being a great investment.