Canada's Housing Bubble

Jan 16, 2010 Garry Marr, Financial Post

Best December ever

The heated debate about whether the Canadian housing market is in the midst of a bubble is likely to continue into this year, thanks to December sales that set a new record for the month.

Existing homes recorded their best December ever as the recovery in the Canadian housing market saw sales climb 7.7% last year from 2008, according to the Ottawa-based Canadian Real Estate Association. Despite the impressive rebound, the 2009 market saw a decline of 10.7% from the record-breaking pace set in 2007.

The stakes are high as the Canadian housing industry battles the government, which has not ruled out tougher requirements for homebuyers to cool the market. Two scenarios rumoured to be under consideration include increasing the minimum downpayment to 10% from 5% and shortening the length of amortizations to 25 years from 35 years -- moves that would drive many consumers out of the market.

This past week the mortgage brokerage industry produced a report showing much of the Canadian market has opted for locking its rates into longer terms, thereby providing a shield against rising interest rates that most predict will come by the middle of this year.

"We think that dismissing housing risks is being a tad Pollyannaish, but it's all the rage in Ottawa circles these days," said Derek Holt, an economist with the Bank of Nova Scotia. "The industry is full of talk of an unsustainable non-bubble, whatever that is, and driving a message that borrowers are all acting out of utter forward-looking brilliance.

"A key debate is whether housing will experience a soft landing toward lower volumes and prices, which is possible, or experience a more sudden decline in activity in the back half of the year and into 2011, which we think is likely."

Mr. Holt is suggesting that as short-term interest rates go up as much 200 basis points by the middle of next year and supply finally builds up in the Canadian marketplace, prices will drop by as much as 10%.

"If you blinked during this cycle, there was no correction," said Mr. Holt, who believes the market needs to have more of a pullback than it did in late 2008 to early 2009. Home prices in Canada climbed 5% in 2009 after falling less than 1% in 2008 -- the first annual drop in prices since 1998.

The Canadian housing market has now had 11 consecutive monthly sales increases on a seasonally adjusted basis, but CREA chief economist Gregory Klump noted the pace has been slowing down for months. "CREA's latest statistics will no doubt spark further bubble talk amongst the usual suspects," he said. "Cooler heads recognize that many of the recent gains reflect temporary factors that could fade by summer."

CREA is still forecasting sales will jump by 7% this year, much of that because the first few months of 2009 were relatively weak. Prices are expected to rise 4.7%, but Mr. Klump said forecast will be updated next month. Historically speaking, 2009 finished up strong, but it's still only the fourth best year for sales since 1980. "It's not even a podium finish," he said.

But there is no arguing housing has had a strong run. The average sale price of a home climbed almost 103% over the past decade, compared to about a 40% increase for the S&P/TSX composite index. By comparison, the average house price increased just 8% during the 1990s.

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