George Athanassakos, a professor of Finance at the University of Western Ontario, recently attracted much attention with his doomsday forecast on the state of the Canadian real estate market.
He argued that relative to incomes, high house prices, combined with record-high household debt levels and overinvestment in residential construction, will spur a “severe” downward correction in the market.
The professor is undoubtedly very learned. However, his hypothesis misses a very important point. He ignores the crucial impact of record-low interest rates on housing affordability. At today’s best five-year interest rate of approximately four per cent, a family’s ability to afford a $400,000 mortgage is the same as some years ago for a $330,000 mortgage, when five-year rates were at six per cent. This same moderating impact influences the severity of average Canadian household debt, which has reached $100,000.
Further evidence that Canada is not at the tipping point of a housing collapse can be found in the continuing low default-rate of Canadian mortgages — less than 0.5 per cent. The comparable default-rate is approximately eight per cent in the U.S.
Because average house prices in Greater Victoria are about 75 per cent higher than the Canadian average, it can be argued that an extra level of caution is necessary in our area. Even locally however, I continue to believe we are due for a relatively normal cyclical adjustment. Almost one quarter of our home-buying activity comes from out-of-area buyers. This takes some pressure off the traditional reliance on first-time buyers to propel market activity above entry levels. Also, with a much higher proportion of seniors and retirees, our average homeowner is far less reliant on a mortgage than in other areas of Canada.
There is no evidence of excess construction in Greater Victoria. Condominiums continue to sell at a brisk pace and to constitute a growing share of all sales — thus reflecting the impact of the affordability squeeze, brought on by recent changes in qualification rules for first-time buyers, as well as a recent interest-rate increase.
Interest rates will continue to increase, but most likely, at a very gradual rate. Our economy is still at a relatively early stage in its recovery cycle. It could not cope well with substantial rate increases. Inflation, the greatest driver of interest-rate increases, is not a significant worry at this time. Significant rate increases would result in further appreciation of the Canadian dollar — to the huge detriment of Canada’s manufacturing sector. All these factors make it likely that the Bank of Canada will tread carefully, for several years to come, with the timing and magnitude of rate increases.
Market price adjustments, in combination with further economic growth, will help improve affordability. Further assistance is likely to come from the development industry which is already moving toward construction of smaller units, both condominium and single-family. There is much room for acceleration of this trend. In the 1950s in Canada, our average single-family home offered about 1,400 square feet of living space. Today, that average is closer to 2,400 square feet.
While high home prices and household debt levels do raise a caution flag, they are unlikely to be precursors of a dramatic crash in the market. We are more likely to see an extended buyer’s market and a modest softening in prices, until affordability improves, and balance is once again reestablished.
A retired corporate executive, enjoying post-retirement as a financial consultant, Peter Dolezal is the author of three books. His most recent, The Smart Canadian Wealth-Builder, is now available at Tanner’s Books, and in other bookstores.