By Julie Fortier, Ottawa Business Journal Staff
Toronto’s real estate market is easing from the break-neck pace of 8 to 14% annual price growth seen from 2001 to 2004. This slowdown, to around 5% so far, may continue with the Bank of Canada’s decision to raise interest rates to cool inflation in the western provinces.
But is eastern and southern Ontario seeing signs of a “cool down” or a bursting of the housing bubble that has seen many homes double in value since 2000?
Many economists and real estate experts who study the Ontario market have said there is absolutely no worry of a housing bubble, let alone a bubble bursting – that is, when price gains level off to 0% or less. Toronto is still a seller’s market, but not at unsustainable levels, according to TD Financial Group economist Pascal Gauthier. “It’s not going to change dramatically downwards or upwards for the remainder of this year or next year. In Toronto, we are looking at 4.9% on average for this year and 5.2% for next year,” he said. It should be noted however, that many economists believe that any price increases above inflation (roughly 3%) are unsustainable over the long term.
“Housing starts are a little bit higher than household formations, so there are slightly more houses being built than households being formed, but it is not out of hand,” Mr. Gauthier said.
He said the real estate industry keeps itself in check because when affordability erodes too much, the market cools because demand goes down.
But that law of supply and demand has been skewed in both Canada and to a greater extent the U.S., where record-breaking low interest rates and new financing and amortization rules have meant that people who might not have been able to afford homes before are able to.
John Haralovich, bankruptcy expert for KPMG LLP, said if there is a slowdown in the manufacturing economy in eastern Canada, coupled with higher interest rates, those who had 100% financing might no longer be able to afford their homes, as is being seen in the housing slowdown in the U.S., and create a glut of houses on the market as people look to sell off.
“Years ago, you couldn’t finance 100% of a home purchase like you can today. Those people are at risk to interest rate hikes, which might in turn fuel a downturn in the housing prices,” he said. “When you’re 100% financed, any ripple in your intake or outtake will create a negative effect. How long that takes you to realize can take 12 months, six months, it’s a personal issue.”
In the U.S., many banks are offering “interest only” mortgages or even a “negative amortization” option, which doesn’t even cover the interest to sub-prime borrowers who in the past could not afford their own homes. In Japan, the 100-year mortgage to pass on to children and grandchildren has emerged as a solution to high housing prices. Canada has not seen these creative solutions to perk up the market yet.
The current situation comes in the shadow of the real estate crash in 1989. At that time, the trough to peak gain was about 70% in only 16 quarters. One of the worst markets was Toronto, where prices fell about 25% after a violent correction in the early 1990s.
After the stagnant growth in Toronto through the 1990s, in which housing price increases slumped close to 0%, housing prices picked up again in 2000.
“After the collapse of the IT boom and a slowdown in the broader economy, the central bank began to lower the overnight rate in 2001 from 5.75% down to a bottom of 2% in 2004,” said Amy Goldbloom of RBC Financial. “Cheap borrowing over this time span certainly helped fuel the real estate markets. Activity in both the new and resale market picked up quickly, with very rapid house price gains booked right across the country.”
There was a slight cooling off in Toronto in 2005 with a 3.8% year-over-year increase, but experts said they expect it to pick up in 2007 and 2008.
However, according to a new Angus Reid Strategies poll, the vast majority of Canadians already feel the current real estate market is pricing them out. The survey, released July 13, found that 74% of homeowners would not have the money to put a 20% down payment on their own homes as currently valued. Most renters felt that buying a home was out of the question in the current market and 65% of this group said they would wait for the real estate market to ease up before looking to purchase.
At the same time, report after report has been released saying there is no real estate bubble in Canada, not even in Vancouver’s clearly out-of-control market (which has been called by Yale economics professor Robert Shiller the most “bubbly” market in all of North America). The average home in Vancouver now demands over 70% of the average household’s income. In Toronto, it is still around 35%.
“After a time, if a market doesn’t cool off it becomes unsustainable. The markets in central and eastern Canada have been cooling if you look at the peaks of 2005,” said Mr. Gauthier. He said that Toronto real estate is no where near the level of western markets, which are seeing 30% growth and beyond. He also pointed out there is still a strong economy with low unemployment, all pointing to a healthy real estate market.
However, Mr. Haralovich believes eastern and central Canada is at even greater risk of a slowdown with increased interest rates and a high dollar. “The east and the west are in two different economic cycles right now. The west is in a growth phase and that might be permanent. The east on the other hand, is being carried by the west, when it used to be the other way around.” He said to use Alberta’s economic growth to explain Ontario’s housing price increases doesn’t make any sense.
Also, any denials from bank economists that a housing bubble is set to burst should be taken with a grain of salt because “it is, by definition, impossible to identify a bubble before it bursts, since rational investors would refuse to hold any asset whose price was certain to fall,” according to a TD report on housing bubbles. That is to say, by declaring a housing bubble, people assume prices are going to crash, so they hold off buying, which causes the crash.
“In economics it’s always a question of a self-fulfilling prophecy. We are dealing with expectations, so what media reports about certain fundamentals on the market will play into people’s consumer’s sentiments,” explained Mr. Gauthier.
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