Report: Housing bubble threat resurfaces as prices in major markets hit 30-year highs

Aug. 31, 2010 | Market Update | By Aaron Rossetti

By Sunny Freeman, The Canadian Press - Home sales may be slowing, but prices in six of Canada's largest housing markets are in bubble territory for the first time in 30 years - and a U.S.-style correction is still not out of the question, according to a report from an Ottawa-based think tank.

The report by the Canadian Centre for Policy Alternatives, to be released Tuesday, says home prices now sit at 4.7 to 11.3 times Canadians' annual income - much higher than historical comfort levels of between three and four times income.

"To see all of the (major) markets outside of that comfort zone is very unique and concerning," said David Macdonald, a research associate who authored the report entitled "Canada's Housing Bubble: An Accident Waiting To Happen."

Sales have fallen by 25 per cent since reaching a peak at the beginning of the year as fewer buyers compete and more houses come onto the market. But Canadian home prices were up 13.6 per cent in June from a year ago in Canada's major cities, according to the Teranet-National Bank composite house price index.

June prices were up 1.5 per cent compared to May - the largest monthly increase since last August and the 14th straight monthly increase.

The steep rise in house prices in so many cities points toward an "accident waiting to happen," Macdonald said.

In the past 30 years Canada's housing market has undergone three bubbles. Bubbles occur when housing prices increase more rapidly than inflation, household incomes and economic growth, according to the report.

Each of Canada's previous bubbles was punctured by only a one per cent rise in interest rates over two years, Macdonald warned.

It would take only a one per cent to 1.25 per cent mortgage rate increase by Canada's big banks to cause a housing crash similar to the one the U.S. is grappling with, he added.

Vancouver saw housing bubbles in 1981 and 1994 and another one burst in Toronto in 1989. In Canada's other major markets - Calgary, Edmonton, Ottawa, and Montreal - prices remained stable from 1980 to 2001 at around $150,000 to $220,000 in today's dollars.

"The concern today is all six major markets, not just Vancouver and Toronto, are out of that comfort zone," Macdonald said. "All six major markets now have an average price of over $300,000."

And the current cooling trend doesn't necessarily signify that the market has emerged from a bubble, he added.

Before Toronto's housing market crashed in 1989, the market saw a similar decline in sales volumes in 1987, but that marked only the halfway point before further increases led to the burst.

Douglas Porter, deputy chief economist at the Bank of Montreal, said that while the report's warnings should not be dismissed as completely improbable, it's clear that the market is backing off bubble territory as price increases subside.

"Given the rebound we've seen in employment in the last year in Canada and the fact that interest rates are still at extremely favourable levels, I can't get that pessimistic on the outlook for housing," he said.

Many economists have concluded that Canada's once overheating housing market, which began to cool in the second quarter of the year, has stopped just shy of a bubble. They credit stricter Canadian lending rules with preventing the type of dramatic crash experienced stateside, where one in 10 households is facing foreclosure.

"A lot of the fundamental differences between the Canadian and U.S. markets suggest that we're far less likely to have the kind of deep downturn that the U.S. market went through," said Porter.

However, Canada is not immune to a serious housing market correction and if prices continue to rise for a prolonged period, even as the resale market slides, that could be a danger sign, he added.

Macdonald said he sees at least a few similarities in home price index data between some American and Canadian cities. Calgary and Edmonton have seen the same price increases as some of the worst-hit U.S. cities, for example.

Canadian homes remain affordable because mortgage rates sit at record lows, but home affordability could change rapidly if rates return even partway to their historic norms, the report warns.

If that does happen, young families who have over-extended themselves and seniors relying on selling their house for retirement income would be most affected.

Macdonald said there's about a six-month to one-year window of opportunity before mortgage rates rise dramatically to "let some air out of the housing market" and help prevent the possibility of future bubbles.

Mortgage qualification changes announced in April, meant to discourage homeowners from taking out mortgages on homes they might not be able to afford down the road, didn't go far enough, Macdonald said.

He argued that the government should change the required downpayment from five per cent to ten per cent to further deter those who won't be able to afford rate increases.

But Porter said there's little point in increasing the minimum downpayment level now as the market is softening on its own.

He pointed out that the bubble bursts of the early 1990s were sparked by the Bank of Canada's decision to raise interest rates to 10 per cent above inflation, aimed at taking down the housing market.

"I don't see the Bank of Canada going on a campaign to lift interest rates to absolutely crush the housing sector. It's just not that much of an inflation concern to them this time," Porter said.

http://ca.news.finance.yahoo.com/s/31082010/2/biz-finance-housing-bubble-threat-resurfaces-prices-major-markets-hit.html