Resistant Bubbles by Gerwin Sturm

According to Capital Economics, the Canadian Housing Bubble is now close to bursting as house prices have lost touch with fundamentals. They predict a 25 per cent decrease of house prices. Others, like Dan Sumner, economist with ATB Financial in Calgary, aren’t so pessimistic. He says that prices could fall significantly “only if major economic shocks occur like in interest rates rising more than expected and commodity prices falling a lot and not temporarily.” Until now, Canadians have survived the recent crisis without any bank failures. Has Canada really prevented the negative effects of its housing bubble, or has the day of reckoning only been postponed?

Price Correction Unavoidable?

“House prices have been growing rapidly for nearly a decade now and it has reached the point where housing is so overvalued relative to incomes that a downward correction seems unavoidable,” said Capital Economics in their Canada Economic Outlook. Other symptoms of a housing bubble are the rapid increase in construction and the very high level of construction employment.

Capital Economics also pointed out that a sharp increase in homeownership and rising rental vacancy rates have both coincided with a house price boom and a run-up in financial leverage. This contributed to growing house supply and over-building that is already evident; the number of unoccupied houses and condominiums is at a record high, resembling the 1994-95 housing slump, when the construction industry experienced a downturn.

“Relative to disposable income per capita, our calculations suggest that housing is around 25 per cent overvalued, which is approaching the level of excess that the U.S. market reached at its peak in 2006,” said the report.

Finance professor George Athanassakos of the University of Western Ontario earlier warned that Canadian home prices are simply too high, especially relative to household income. He added that signs of stress are already visible: “The average Canadian family debt hit $100,000 in 2010. About 17,400 households are behind in their mortgage payments, representing an increase of nearly 50 per cent since the start of the last recession.”

In Calgary and the Rest of Alberta

Man at Work by Elliott Brown

The economic prospects aren’t so unfavourable for Calgary and the rest of Alberta. “Deriving conclusions on the state of the real estate market nationally does not accurately depict the local market within each region, and certainly not the Calgary market,” said Sano Stante, president of the Calgary Real Estate Board. TD Economics predicts that sales in Calgary will decline by 8.8 per cent from peak to trough over the two-year outlook, and prices are expected to fall by 6.4 per cent.

Dan Sumner, economist with ATB Financial in Calgary, claimed that the housing market in Alberta hasn’t been developing as rapidly as the rest of the country over the past three years, which means it’s less susceptible to a decline now.

Modest Correction

We shouldn’t expect a burst of the same intensity that the US experienced. Canada’s banking system is the world’s soundest financial system. It is more prudent, and mortgage rules are less liberal than they were before the crisis hit the US. However, while Canadian personal income is very low compared to home prices, the home price increase can’t continue growing so steeply. “The only way for commodity prices to fall materially is if Asia went into a major recession — possible, but not likely,” added Dan Sumner.

According to TD Economics, resale activity will drop by 15.2 per cent and average prices are likely to fall by 10.2 per cent over the next two calendar years. However, most of this decline will happen in the places that have seen the biggest price growth over the past two years: Toronto, Montreal, and Vancouver.