There are enough signs suggesting a correction is in the offing

Kunal Sawhney, chief executive, Kalkine Group

Bubble or no bubble, unfounded price rise or supply side pressures, analysts seem to have no consensus on what’s happening in Canada’s housing market.

The rise in the value of almost every asset over the past one and a half year is perplexing. Not just houses, many listed stocks in Canada are also hovering at record highs. Even the volatile, speculative crypto asset market is witnessing relentless inflow of funds from both retail and institutional investors. In all markets, there seems to be a bubble – a bubble that owes to high liquidity, thanks to low interest rates and Canada’s stimulus program.

Kunal Sawhney

The latest warning by a banking institution

Swiss banking institution, UBS, has lately issued a strong warning about the housing market. And it’s not about Canada alone, but most developed countries that are seeing an unprecedented buying frenzy.

Findings by UBS are much closer to reality than any assumption based on qualitative factors. The bank has compared prices of housing assets with income levels and other financial stats. Markets in Europe, North America and Asia have been grouped under five categories – from depressed (very low prices) to bubble (highly disproportionate prices). Two cities of Canada — Toronto and Vancouver — have easily made the cut to the bubble category.

According to the analysis, housing asset prices have doubled over past 10 years. The bank says that a few interventions by the government that include taxes on overseas buyers had a limited effect on prices.

The findings by UBS are pretty similar to a report by the Urban Reform Institute and the Frontier Centre for Public Policy released earlier this year. The report listed major world cities by their unaffordability, and Vancouver was second only to Hong Kong. Not to forget Hong Kong has high population density and income levels are high with high disparity, and hence high housing prices. Toronto, too, made the cut in the top five most unaffordable cities where housing affordability was assessed for the third quarter of 2020.

Prices still high, but until when

The report by the Urban Reform Institute relates to the third quarter of last year.

Now consider this. In August 2021, the average selling price of a house was nearly C$660,000, according to the Canadian Real Estate Association (CREA). This was 13% more than previous year, and hence the market is now arguably even more unaffordable considering income levels can barely rise in the same proportion.

If C$660,000 is too high, what about C$715,000, which was the average price in March 2021, according to CREA.

One can say that the signs of cooling are evident in the fall in prices between March and August. But this limited cooling isn’t in prices alone, sales volume has also dipped by a huge margin. 14% fewer houses sold in August 2021 as compared with August 2020. The signs are of stagnation, not cooling. The latter is something when sales volume is either constant or growing but prices are falling.

It is coming – the end of low interest rates

The hot housing market of Canada wasn’t just a playground for the rich. Many middle-class households jumped onto the bandwagon, thanks to cheap mortgage interest rates. The Bank of Canada had cut policy rates in March last year in the wake of the pandemic, and this translated into cheap and abundant money.

But the real monster – inflation – is rearing its ugly head. Data by Statistics Canada suggests that price rise in September 2021 was at its highest level in 18 years. From food and shelter to energy and new cars, everything is becoming costlier. The prices of gasoline were up by over 30% in September on an annual basis. Now it is easy to conclude that people are spending more on necessities and saving less, and the impact might soon reflect in all markets, including housing. Even meat prices are up nearly 10%.

For long, the Bank of Canada snubbed inflation concerns as ‘transitory’. The Bank was of the view that the prices will only rise for a short period, with correction coming once the global supply chain emerges out of the pandemic shock. Sadly, the supposition was anything but accurate.

The Bank seems to have realized that this rising cost of living isn’t transitory, and it has ended the bond purchase program to suck at least some liquidity from the market. With less money, maybe people will be inclined to buy less, and a dipped demand may cool down prices of necessities. Policy rates may not be hiked yet, but the Bank’s tilt toward a tighter monetary policy is unmistakable.

Further cooling is expected

Consider this. In a recent statement, the Food Banks Canada’s CEO cited high food and housing prices as a reason behind more people visiting food banks in Canada. Toronto – the city that finds place in almost every list tracking unaffordability – has an even more strained food bank scenario.

There are enough signs that predict a correction in housing prices, if not the crash of the bubble. First, the Bank of Canada might increase rates earlier-than-expected, which would make mortgage costlier. Second, and most decisive, the economic rebound has yet to reach a level where demand for housing assets owes to natural factors like high employment and wage growth. Lastly, the market is truly too hot to sustain a large number of headwinds. A correction is likely in the making, and may hit anytime.

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