Toronto Condo & Real Estate Blog

Is the Canadian housing market rising or sagging?

By Jay Bryan, The Montreal Gazette

Depending on who you listen to, home prices in Canada are either rising briskly or sagging sadly.

The latest national measure, the Teranet-National Bank House Price Index, gave a shot of optimism to the market yesterday, showing a strong price gain in major cities, but it reflects conditions a few months ago.

Earlier this month, the Canadian Real Estate Association, or CREA, issued a gloomier assessment that showed prices in July continuing a decline it first detected in May. But this survey must be interpreted with caution because its average house prices are distorted, sometimes seriously, by changing conditions in the market.

So what’s the truth? We’ll try to get closer to that, but if you don’t enjoy economic analysis, here’s a reasonable bottom line: the real-estate market is neither booming nor collapsing. Instead, it’s likely headed for a couple of years of either stagnation or mild price declines.

The reason we can’t be more precise is that the housing market seems to be faltering after a powerful recovery, a condition that makes it particularly hard to measure prices accurately.

At turning points like this, CREA’s monthly measure of average home prices is highly valued. It gives the quickest indication of when and how much the market might be weakening.

Sure enough, the MLS numbers were the first to signal a weakening market, showing the number of home sales falling at an increasing pace since early this year.

After a while, prices followed. The best price measure provided by CREA, one that’s adjusted for seasonal variations, peaked in April and fell by a total of 3.7% through May, June and July.

But there’s a problem with this yardstick. It contradicts the carefully constructed Teranet index, which now shows prices rising through most of this period. Indeed, the monthly gain in June was a particularly strong 1.5%.

“There are few issues more important to the Canadian economy at the moment than whether or not house prices are falling,” says economist Derek Holt at Scotia Capital, so it’s important to figure out what’s really happening.

The answer is important because a major decline in house prices can trigger a serious economic setback as it erodes consumer spending and homebuilding activity, both major economic drivers. An extreme version of this scenario is playing out in the U.S.

Happily, Holt and other analysts are pretty sure that nothing of the kind is in the cards for Canada. What’s at stake here is simply whether we’ll have a mild housing downturn, which will slow growth for a year or two, or not. The betting now is that we will.

And the reason for the divergence between Canada’s two key measures of housing markets is simply that they’re measuring different things.

The CREA index does a very good job of measuring market conditions because it keeps an accurate tally of transactions and listings, so we know how fast the average listing is selling.

But its measure of prices is flawed. It simply averages out the price for all sales in a particular month. If today’s very high home prices have induced buyers to shop for something smaller and simpler than people were buying previously, it can’t adjust for that, although the Teranet index does.

In such a case, we’d see the average price from CREA dropping even as the price of more modest homes kept rising, because fewer costly homes would be included in the average. But the Teranet index, which measures resales of the same home, could keep going up, because it is not affected by the mix of homes sold in any month.

“From my own limited observation of my market, I think that’s exactly what’s going on,” said Douglas Porter, an economist in Toronto with BMO Capital Markets. “High-end homes hit a wall this spring when the stock market dropped.”

Holt, too, thinks that this is at least part of the reason for the divergence in the two price yardsticks, and National Bank economist Marc Pinsonneault agrees that it’s a possible explanation.

So the picture we’re left with is that the Teranet index, which is very accurate, is a little slow to react to a market slowdown, while the CREA price average can actually exaggerate such a slowdown.

Looking at the whole picture, though, it seems very likely that a housing market slowdown is beginning.

A Toronto-Dominion Bank analysis concludes it will knock a few percentage points off next year’s average price compared with this year’s, then hold gains just above the inflation rate for the next few years.

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