Where Canadian Home Prices Heading!?

For a couple of weeks there been many announcements that the time of low mortgage interest rates is coming to an end. Which I believe to be true, if economy will be growing at today’s levels and nothing major will offset current trends.
RBC projects that “a stronger economy will offset the effects of higher mortgage rates and keep Canadian house prices stable over the next two years”.

In a market update, economist Robert Hogue said : “After two years of “gyrating wildly,” the Canadian housing market is likely to be a much less interesting place for the next several years.”
There are combination of nearly perfectly offsetting factors influencing Canada’s housing market. While economy is recovering in 2011, it will continue to boost employment and family incomes, but on the downside, mortgage interest rate are expected to rise.
I do have an issue with this statement. Employment does look better today than a year ago, but I can point out many trends that will offset these numbers. One of them, is that, people are taking lower paying job offers compared to what they were making before, so the family income is not necessary is going to rise. That’s why employment statistics will present us positive growth numbers, but family income could diminish in reality. This alone will greatly offset buying power together with an interest rate increase.
Also RBC predicts that “The Bank of Canada will likely raise interest rates by 100 basis points this year and another 150 basis points in 2012, making mortgage payments more expensive for the majority of homeowners. But real gross domestic product is expected to increase to 3.2 per cent in 2011 from 2.9 per cent in 2010.”
“The net effect of these forces is expected to be close to nil, thereby leaving resale activity largely flat,” said Robert Hogue.
I will not necessary agree with Robert again... Yes, a domestic product growth is good, but it will not necessary affect everyday Canadians instantly. Corporations usually do not instantly increase wages with increase in profit lines..... Correct me if I’m wrong, but in reality wage increase do not came that easy. Therefore Mr. Hogue, higher interest rates on revolving credit (lines of credit, etc..) and higher mortgage payments, will affect Canadians significantly, at least for a short period of time (3-5 years), before they will receiving benefits of higher GDP and income growth.
There have been a tons of forecasts issued in the last week, as the market starts the year stronger than expected. Capital Economics issued a cautious report that suggested higher interest rates could drive prices down as much as 25 per cent over the next three years, while the Canadian Real Estate Association raised its sales forecast for the next two years as it suggested that a stronger economic recovery and continued low interest rates would keep the market balanced.
“Even though mortgage rates are expected to rise later this year, they will still be within short reach of current levels and remain supportive for housing market activity,” CREA chief economist Gregory Klump said. “Strengthening economic fundamentals will keep the housing market in balance, which will keep prices stable.”
In my opinion Mr. Klump should reconsider his statements, or perhaps add, CREA only gives a short term forecast based on past trends.... I don’t remember them telling people that prices of real estate being ridiculously high during March – May of  2010, and many people who will purchase large homes during this time, most likely won’t see appreciation for a very long period of time ...
On the other hand Capital Economics economist David Madani said too many optimistic forecasts are based on too short a time frame to be useful, because many mortgages won’t reset until rates rise much higher than they are today.
“Let’s balance this discussion a bit and think longer term,” he said in a recent interview. “As far as housing prices are concerned, we think they’re overvalued and we don’t see income growth closing that gap.”
To support his statement, I will give you a simple arithmetic example: usually home prices where in range of 3.5 times of worker’s income on average. So, family making 80 000 dollars was buying a home priced around 280 000 thousands. Today home prices 5.5  times of household income (I believe x7 times in BC). Meaning that the same home will cost 440 000 dollars!!!! How many of you really believe that your income will increase 57 per cent to support historical fundamentals?

Also, a spread between rent and home price is widest in history. Today’s ratios higher than during a Bubble of 1989.... Guess what, there is no possibility for rents to increase significantly due to affordability and rent controls imposed by the government. Real Estate investors are not making descent rates of return anymore, therefore prices must adjust accordingly as well.
Said that I don’t see home prices falling 25 – 35 per cent from today’s levels. We already had a fairly significant drop since last year. Also there are other forces that stimulate Canadian market activity. That’s why I would say we may see a decrease from 5 – 15% for certain markets and home types.
Therefore, if you are in a mood to buy a house or a condo, don’t be in a rush. Do not be afraid of new mortgage rules. A shorter amortization will not affect you, because most likely you will be buying a cheaper home, so it will not increase your payments and a down payment.
If you have anything to add or need clarifications, don’t hesitate to ask me, or comment below.
Have a great day,
Dmitri Ivanov
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