Canada's Housing Bubble

Dec 20, 2011 Mario Toneguzzi Calgary Herald

CALGARY — A report by Bank of America Merrill Lynch says Canadian home prices are now showing many of the signs of a “classic bubble.”

“We estimate the housing market nationwide is about 10 per cent over valued,” says the report released on Monday by economists Ryan Bohren and Sheryl King. “Even so, the only way these valuations can be explained is by the record low mortgage rates. Under more normalized interest rates, home prices would actually look 25 per cent overvalued based on current prices.”

The report says Canada is somewhat shielded from the economic fallout from the European debt crisis but is certainly not “impregnable” particularly if unemployment goes to about eight per cent.

“In our view, the housing market is one of the most vulnerable sectors to this weakening economic environment, showing classic signs of over valuation, speculation and over supply,” says the report. “We are not calling for an all out rout in the market — but caution is now decidedly warranted.”

According to the Canadian Real Estate Association, the average MLS sale price in Calgary in November was $398,722 which was basically the same as a year ago while the Canadian average price grew by 4.6 per cent to $360,396.

In Alberta, the average price of $356,535 increased by 2.7 per cent.

“The Canadian housing market is proving resilient in the face of ongoing global economic and financial uncertainty, to the benefit of Canadian economic growth,” said Gary Morse, CREA’s president, in a statement when the data was released recently.

The Bank of America Merrill Lynch report says Canadian households are heading into 2012 with record debt and facing a possible spike in unemployment to eight per cent.

The report says it expects some “slippage” in home prices starting in 2012.

Under its base case scenario, the report says it expects housing investment to contract about five per cent in the first half of 2012 “as the economy flirts with recession.”

“Home prices will likely contract slightly in the first half of 2012 as housing demand slows on tougher jobs and income growth environment, but end the year flat as economic activity accelerates in the back half of the year.”

But under a more “adverse” scenario, the Canadian housing market would likely experience a hard landing as it is highly leveraged to jobs and income growth.

“Moreover, the household balance sheet is stretched and highly susceptible to adverse shocks,” it says. “A spike in the unemployment rate would certainly lead to a pullback in credit demand and leave the multi-unit market significantly over supplied. This market would also likely result in a rise in delinquencies and forced selling, which would see homes prices decline by around 10 per cent.”

In its fall Housing Market Outlook, Canada Mortgage and Housing Corp. forecast the average MLS sale price in the Calgary census metropolitan area to be $402,000 this year, a 0.8 per cent increase from a year ago and it predicts a 2.2 per cent hike in 2012 to $411,000.

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