Fear of housing bubble seems overblown

One of the country's leading economics think-tanks, the Conference Board of Canada, has become the latest entrant in the long-running debate over Canadian housing prices. Its take: no bubble. This contrasts sharply with a report last week from the Canadian Centre for Policy Alternatives, which said Canada's "housing bubble" is "an accident waiting to happen."

Back at the Conference Board, economist Mario Lefebvre acknowledges that home sales have fallen sharply this year, but points out that this is hardly a sign of distress after a period when sales were far too high to be sustainable. Instead, he concludes, it's just a return to normal.

More important, on the price front, "there's been no decline to talk about," Lefebvre said.

Prices rose in July from June in 19 of 28 Canadian cities and all 28 had prices that were above year-ago levels.

That's not to say that prices will keep rising.

Lefebvre expects to see a "pause" in price growth for most cities in the next year or so as Canada's economic growth slows. And prices could edge down by two to four per cent in the hottest western markets, like Vancouver, Calgary, Edmonton, Regina and Saskatoon. But that's hardly a bust.

This is a stark contrast to the truly frightening housing outlook published last week by the Canadian Centre for Policy Alternatives, a left-leaning non-profit group that said a worst-case scenario for the bursting of the housing "bubble" would see prices plummet by 20 to 38 per cent in the biggest Canadian cities. Even its best-case scenario would envision drops of between 19 and 29 per cent.

This is a truly horrendous scenario. The catastrophic recent U.S. housing meltdown saw a national drop of about 30 per cent.

It's hard to accept that people looking at the same Canadian housing market could come to such wildly different conclusions, but if you look behind the numbers, a clearer picture begins to appear.

The Centre for Policy Alternatives analyst, David Macdonald, begins with the assumption that there's a reasonable range of housing prices determined mostly by people's median income. (Median income is the level at which half the population is above and half is below.)

Macdonald looked back at the 1980s and 1990s and found that during the whole period, home prices stayed between three and four times the median income, while home prices today seem badly out of whack at between 4.7 and 11.3 times this measure.

But maybe that's because the yardstick is out of whack. Lefebvre of the Conference Board wouldn't dream of using this measure.

That's because it doesn't take into account the huge impact of mortgage interest rates, which have varied greatly over the years, directly affecting people's ability to pay for a home.

At today's low mortgage interest rates, housing affordability is pretty good in most Canadian markets, Lefebvre said, and he's not too worried about a rise in interest rates, since rates are rising only gradually.

As well, he said, Macdonald's concern that home prices have risen faster than incomes over the past decade overlooks a crucial fact: that home prices lagged badly during the previous decade.

Robert Hogue, a senior economist at the Royal Bank of Canada, has worked out the numbers on affordability in some detail, and his conclusion is essentially the same as Lefebvre's: there's no bubble today and little prospect of significant price declines tomorrow.

Hogue suggests that a possible exception is Vancouver, where prices are sky-high, and maybe Montreal, where prices are still fairly low, but have shot up rapidly in recent years.

While it's true that interest rates will put a little more stress on homeowners over the next year or two, Hogue simulated this by calculating the impact of adding 1.5 percentage points to today's mortgage rates. He found little cause for concern.

His finding: affordability would deteriorate only moderately, with home ownership costs representing about 46 per cent of median income for a typical bungalow, up from 41 per cent today.

This would still fall far short of the 54-per-cent home ownership burden that helped spur a severe housing bust in 1990. And the 46-per cent estimate is probably high, since rising Canadian incomes will partly offset rising interest rates.