Competing views of the Canadian housing market portray it as either 1) an overvalued bubble about to burst or, 2) only slightly overheated but having basically sound economic underpinnings, and thus likely to cool gently. The Conference Board of Canada's new publication, Housing Briefing: Bubble Fears Overblown, lands in the latter camp.
Mortgage costs, not just house prices, are the principal deciding factor for potential home buyers. This makes comparison of monthly payments to incomes and rents more relevant than similar comparisons using house prices alone. Slowly rising mortgage rates and a modest slowing in housing starts will gradually cool the housing market. But ongoing employment and population growth will continue to support housing demand.
Assessments that point to a housing bubble typically rely on two main indicators: The ratio of housing prices to apartment rents, and the ratio of incomes to housing prices. By both these measures, many markets in Canada do seem overvalued at first glance. However, this ratio doesn't account for low mortgage rates.
Low interest rates since early 2009 have cushioned the impact of rising house prices, keeping the relationship of carrying costs to incomes and rents well within historical norms. For example, in Toronto, mortgage payments consumed less than 20 per cent of average household incomes in 1993 and in 2013. Mortgage payments were roughly twice the average two-bedroom apartment rent in both years.
In this context, Toronto's affordability is mirrored nationally. The Bank of Canada's affordability index has stayed virtually unchanged since the 2009 recession, and is actually slightly below its pre-recession level.
The Conference Board expects mortgage rates to rise over 2014, but not sharply, given Canada's relatively slow economic recovery. This suggests that a slowly cooling housing market – a "soft landing," rather than a "bubble popping" – lies ahead. It will take until 2017 or 2018 for mortgage interest rates to rise by about two percentage points.
Moreover, the Conference Board's current view is that more prudent mortgage underwriting in Canada than in the United States, headlined by the very small number of subprime loans here historically, has prevented the stockpiling of high-risk mortgages by lenders. Over the past two years, the proportion of mortgages in arrears has generally fallen across Canada. A relatively low proportion of arrears is likely to persist, since national employment is growing – albeit slowly – and interest rates are not forecast to spike.
If there were a downturn centred on markets in Ontario and Quebec, national resale prices would be expected to decline slightly. But none of Canada's six largest cities appears significantly overbuilt by past standards. In general, housing starts are in line with demographic requirements. Nationally, and for each of six metropolitan areas (Toronto, Ottawa, Montreal, Calgary, Edmonton, Vancouver), the data show no obvious overbuilding, although Toronto is an important borderline case.
Oversupply in Toronto's condominium market remains a risk, largely because of an all-time high number of units under construction. Yet, Toronto developers seem unfazed by this volume. Condominiums are a logical choice for Torontonians who want or need to live downtown, and a tight rental market increases interest in condos. This analysis concludes that the Toronto market will ultimately cool and increases in the average resale price will slow, but a big price drop will likely be avoided.
In short, steady employment and population growth will help offset the effects of interest rate increases, maintaining manageable housing demand. Thus, a soft landing for the Canadian housing market appears to be the most likely scenario.
Robin Wiebe is senior economist, Centre for Municipal Studies, at the Conference Board of Canada, and author of "Housing Briefing: Bubble Fears Overblown"