John Pasalis in Toronto Real Estate News

For the past cou­ple of months I have been cau­tion­ing our read­ers against mak­ing any big con­clu­sions about Toronto’s real estate mar­ket based solely on changes in aver­age prices. Toronto has seen a big decline in the num­ber of sales of high end homes this year which has been exag­ger­at­ing the decline in prices. For more on this read my pre­vi­ous posts Toronto Land Trans­fer Tax Exag­ger­ates Hous­ing Price Decline and Mak­ing Sense of Toronto’s Real Estate Decline in Octo­ber.

At a national level, econ­o­mists from TD Eco­nom­ics noticed that national aver­age prices were being skewed down because of steep declines in sales in British Colum­bia, where aver­age home prices are the high­est in Canada. Last month TD Eco­nom­ics pub­lished a report titled A Dif­fer­ent Look at Cana­dian Home Prices where they intro­duced the TD Home Price Index as a more accu­rate way to mea­sure changes in national prices.

I invited one of the authors, Econ­o­mist Grant Bishop to answer a few ques­tions about their report.

John Pasalis: Hi Grant, thank you for tak­ing the time to answer a few ques­tions about your report. Can you start off by explain­ing why Canada needs a Home Price Index? What’s wrong with using aver­age prices to track national house prices?

Grant Bishop, TD Eco­nom­ics: National-level aver­age prices are dis­torted by swings in sales vol­umes across dif­fer­ent mar­kets. By apply­ing con­sis­tent weights, an index strips away these market-specific swings and is a bet­ter indi­ca­tor of the value of hous­ing nationwide.

Presently, house prices at the national level are reported as an aver­age across all prop­er­ties sold in the month, quar­ter or year. The prob­lem is that the aver­age house price is reported as rep­re­sen­ta­tive of the aver­age value of the hous­ing stock. It is only a mea­sure of those houses sold; not those that never went on mar­ket. Cer­tain high-priced or low-priced mar­kets may expe­ri­ence rel­a­tively high or low sales vol­umes in any given period. The num­ber of sales is highly vari­able between cities and over time. Sales vol­umes can thereby gen­er­ate unrep­re­sen­ta­tive swings in observed house prices.

An aggre­gate mea­sure at the national level should pro­vide a con­sis­tent pic­ture of how home val­ues are chang­ing over time.  The index should be rep­re­sen­ta­tive of the stock of hous­ing rather than just those houses that are sold. An index that removes the effect of momen­tar­ily hot mar­kets is nec­es­sary to remove the dis­tor­tion from these tem­po­rary high sales volumes.

As a styl­ized exam­ple, con­sider two cities each of 100 homes. In city A, all houses are worth $200K. In city B, all houses are worth $100K. The aver­age value of hous­ing is then $150. How­ever, con­sider a period where 30 houses are sold in city A at $200, and 10 houses are sold in city B at $100K. The observed aver­age price is then (30 x 200K + 10 x $100K)/(30 + 10) = $7000K/40 = $175K. Because more houses were sold in the higher value city A, the aver­age price was dis­torted upwards.

As a more con­crete exam­ple, from the 1981 cen­sus, Van­cou­ver con­sti­tuted 9.3% of all owner house­holds in our 24 city sam­ple. From the 2006, cen­sus Van­cou­ver con­sti­tutes 10.5%. Despite inter­provin­cial migra­tion, a given city’s pro­por­tion of home­own­ers moves rel­a­tively slowly over time. Com­pare this with sales vol­umes: In July 2007, Van­cou­ver rep­re­sented 8% of all national sales. By July 2008, Vancouver’s sales were down to 5% of the national aver­age. Van­cou­ver is a high-priced city and its lower sales vol­umes dimin­ish its weight in the national-level aver­age, dis­tort­ing this mea­sure down­wards. In con­trast, an index ensures con­stant weight­ing so that the national-level mea­sure bet­ter rep­re­sents the price of the over­all stock of housing.

As a macro­eco­nomic indi­ca­tor, home val­ues are very impor­tant. Cana­di­ans hold around 35% to 40% of their wealth in their prin­ci­pal res­i­dence. Home val­ues then have a sub­stan­tial impact on house­holds’ deci­sions to spend, work, and invest. It’s impor­tant that we’re con­sis­tently gaug­ing this indi­ca­tor. More­over, even though peo­ple buy houses locally, not nation­ally, the impact of such reported swings can cre­ate mis­per­cep­tion about the value of one’s own home, induc­ing more pes­simism or opti­mism than is warranted.

CREA’s [Cana­dian Real Estate Asso­ci­a­tion] aver­age of house prices is cer­tainly not wrong. It mea­sures what it mea­sures. How­ever, as a mea­sure of the value of hous­ing, we con­tend that an index with con­stant weights is a more con­sis­tent gauge. An aver­age of sales is prone to swings in dif­fer­ent mar­kets and thereby mis­states the actual aver­age value of the stock of housing.

John Pasalis: How does the change in aver­age prices reported by CREA com­pare to the change in TD’s Home Price Index?

Grant Bishop, TD Eco­nom­ics: CREA’s house price in Octo­ber was down 10.9% Y/Y while the TD HPI showed a less steep decline of 4.6%. From 2002 until early 2008, the year-over-year per­cent changes within the TD HPI were gen­er­ally con­sis­tent with CREA’s aver­age. Over that period, the level of CREA’s aver­age gen­er­ally exceeded that of the TD HPI. For instance, when house prices peaked in May 2008, the TD HPI records a $340,046 price while CREA reports $345,362. How­ever, the great­est – and most impor­tant – dif­fer­ence has been dur­ing the post-2007 period of decel­er­a­tion and decline. But turn­ing points are when accu­racy counts most. With house prices now in a year-over-year decline, it’s crit­i­cal to gauge the mag­ni­tude of the fall consistently.

John Pasalis: The TD Home Price Index does not con­trol for unit-type shifts (e.g. changes in sales vol­umes of high end homes vs. starter con­dos). If you could take unit-type shifts into account, what impact do you sus­pect that would have on the Index.

Grant Bishop, TD Eco­nom­ics: Using repeat sales to con­trol for qual­ity across time is an impor­tant fea­ture of the S&P/Case-Shiller index that is used in the United States. The TD HPI strips away the dis­tor­tion caused by sales vol­umes in dif­fer­ent mar­kets. How­ever, we agree that con­trol­ling for unit types and qual­ity is key. Given the down­turn in the mar­ket, it is likely that we would see a lower decline if con­trol­ling for unit types. Specif­i­cally, higher qual­ity homes will likely be held off mar­ket to a greater degree and new home­own­ers will likely look down mar­ket. This would mean that the aver­age price from observed sales would be biased downwards.

We do project a move­ment towards higher den­sity and lower cost units. In a large cen­tre like Toronto, this has both cyclic and struc­tural ele­ments: Over the down­turn, income growth will stag­nate and younger cohorts espe­cially will look towards cheaper options. Retir­ing boomers are prone to down­siz­ing. Although the lat­ter may buoy the lux­ury condo mar­ket, their new condo will likely be cheaper than the single-detached that they’re cash­ing in. Of new hous­ing, we project a more rapid fall in sin­gles con­struc­tion than in mul­ti­ples. Over­all, the near-term trend should be for “ham­burger rather than steak”.

In the data, we see Toronto over­all sales declin­ing year-over-year (-22% in August and a fur­ther –7% in Sep­tem­ber), but these were led by declines in sales of single-detached units (-24% in August and a fur­ther –9% in Sep­tem­ber). Town­houses and con­dos sales have also declined year-over-year but not quite to the degree. As well, although there’s a decline in price story as well, the pro­por­tion of Toronto homes sell­ing over $500K have declined from 18% of sales to around 14%. Indi­ca­tions are that those who can wait to sell are doing so.

John Pasalis: What do you feel is the key take away mes­sage from your report?

Grant Bishop, TD Eco­nom­ics: Firstly, Canada needs bet­ter hous­ing data, and con­sis­tent mea­sures of prices. Homes are very impor­tant to fam­i­lies, and hous­ing plays a large role in the economy.

Sec­ondly, espe­cially in a period of high volatil­ity, it’s impor­tant to mea­sure indi­ca­tors con­sis­tently. Any sta­tis­tic can be biased by its mea­sure­ment and is key to con­sider what is really being measured.

John Pasalis: What’s your out­look for Canada’s real estate mar­ket over the next year?

Grant Bishop, TD Eco­nom­ics: Over the com­ing year, we fore­cast a price decline of –6.1% nation­wide under our base-case fore­cast and a –10.7% under our pes­simistic sce­nario. The great­est declines will be seen in the over­built mar­kets of West­ern Canada where the shock to com­mod­ity prices will markedly depress income growth.

Between our base-case and pes­simistic fore­casts, the devil’s really in how credit tur­moil is resolved and plum­met­ing con­sump­tion rebounds state­side. Canada is being buf­feted by the three C’s (credit, com­modi­ties, and cross-border trade) and this is going to cause stag­na­tion in income growth for Cana­di­ans over the com­ing year. The high ero­sion of afford­abil­ity shows that prices had dis­con­nected from incomes and this is now being reined in rapidly. In the long-run, house prices can’t exceed what peo­ple earn, have saved, or banks are will­ing to lend on the basis of their future earn­ings. We expect prices to return to a more afford­able level that is more in line with income growth and inter­est rates.

John Pasalis: What’s your out­look for the Toronto real estate mar­ket over the next year?

Grant Bishop, TD Eco­nom­ics: Our fore­casts for Ontario are for a decline of –4.5% under a base-case and –9% under a pes­simistic sce­nario. By sales, Toronto com­prises 40% to 50% of the province’s real estate mar­ket. The province and its major city are going to feel severe strains from the down­turn in exports and a sag­ging man­u­fac­tur­ing sec­tor. How­ever, the GTA should nonethe­less fare bet­ter than the outer Golden Horse­shoe, where there are signs of over­sup­ply. Afford­abil­ity in Toronto is within rea­son­able lim­its but prices will nonethe­less feel some sig­nif­i­cant down­wards pressure.

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Con­tact the Jef­frey Team for more infor­ma­tion – 416−388−1960

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