2010’s First Dip In Home Prices

The average Canadian home value fell 1.2% in June. It was the first drop of 2010.

Canadian-Average-Home-PriceThere’s one thing about price declines:  They’re good at making people ask: “Now what?” 

The answer is pure speculation, as usual, because housing—like the economy, interest rates, and the weather—can’t be predicted long term.

Nonetheless, while one month does not a trend make, there is a somewhat bearish tone in real estate these days.  Below are the latest assessments from some well-known observers…

  • “With interest rates on the rise, housing affordability and home sales activity are expected to continue to erode over the second half of 2010.” – Gregory Klump, chief economist, Canadian Real Estate Association
  • "An expected increase in the supply of homes on the market will now bring stabilization in prices, and in some cities we will see both prices and unit sales decline towards the end of the year.” — Phil Soper, president and chief executive, Royal LePage Real Estate Services
  • “As we cross into the second half of the year, we expect to see a continued easing in activity.” – TD senior economist, Pascal Gauthier
  • “…excesses in one direction are generally followed by excesses in the other direction…In a nutshell, there's more air to come out of this Canadian housing balloon.” — Gluskin Sheff + Associates Inc., economist, David Rosenberg

Few analysts predict an outright crash, though. Most are calling on a strengthening economy and employment to pad the fall. But again, it’s all speculation based on future uncertainty.

That uncertainty is prompting some first-time homebuyers to think extra long about their buying decision. In the last few months, we’ve come across a fair number of home buyers who are hesitant to buy because they expect prices to fall.

CIBC, for example, expects a 5-10% drop by summer 2011. Suppose, for illustrative purposes, we averaged that to a drop of 7.5%.  If the economy continues its recovery and fixed rates rise 1%, the mortgage picture could pan out something like this (these aren’t predictions, just a hypothetical):

TODAY

  • Average Canadian home price: $342,662
  • Typical 5-year fixed rate:  4.09%
  • Payment w/ 35-yr amz & 5% down:  $1452

JULY 2011 (HYPOTHETICAL)

  • Average Canadian home price: $316,962
  • Typical 5-year fixed rate:  5.09%
  • Payment w/ 35-yr amz & 5% down:  $1526

Thus, a person looking to buy an average house in this scenario pays $74 more a month by waiting a year to buy, but saves $25,700 on the price.

Mind you, you have to adjust for rent expense (people need to live somewhere while they’re waiting to buy), property taxes, etc. But still, someone could easily make an argument that waiting to buy is the most economical decision in certain real estate markets—even if rates go up.

This isn’t meant to scare people from buying homes. But if you’re looking to buy with only 5% down, it should make you think a bit. People with little equity need to have a long-term time horizon and solid employment prospects, because real estate risk has undeniably increased.

_____________________________________________________

Sidebar Question: What’s the probability of home prices dropping the month after the first decline in six months?

Answer:  45% (based on 55 occurrences since 1980)

  1. Interesting comparison – for those who are a bit more conservative I ran it with a downpayment of $47500 (15% of 316) and a 25-year amortization. In that case the monthly payment rises from $1566 to…. $1580.
    The more you can accelerate your payments in the first place the less this would affect you – after all you’re paying less interest overall so you can more from a price drop than you lose on the interest. It’s those who can only manage 5% and 35 years that would be most likely to want to buy before a decline in prices and a rise in interest rates.

  2. The numbers in Toronto do NOT look good at the half way mark of July. Inventory is WAY up (already surpassing all of last July). Sales are down as well. I’m not saying there’s a crash but watch for the esclated panic talk when full July numbers are in.

  3. I’m on the sidelines myself (ie expecting prices to fall), but your post rings a little alarmist to me. It would be very difficult for inventory to *not* be much higher than last year, given how low inventory rates were in 2009.
    With respect to sales, I can’t see July’s numbers until TREB posts them in a press release. Anyone know where numbers can be found during the month?

  4. If home prices start to fall (crash?), do you think that interest rates will come down as well to encourage buyers and stabilize the fall? Or will this lead to higher inflation?

  5. What people dont see is that you are paying $100 more monthly for 5 yrs, which is $6000.00, But you will save $25000 on home prices. After 5 yrs you are in the same boat as to buy today or wait for 1 year.

  6. The interest rate only applies to the first 5 years of 35 years!. This comparison is biased. They should take an average interested rate over several years to do the comparison.

  7. No insult intended here but your post is completely off the rails, 90% of the people re-mortgage after 5 years, no one can predict if rates will be lower or higher in July 2015 or July 2016.

  8. I whole-heartedly agree. The price you pay for a home (and hence the amount of your debt) is locked-in. The interest rate will fluctuate. Buying a home at a historical lower price will always be better than buying at a higher price, regardless of the prevailing rates.

  9. Hi $.02,
    I’m afraid I don’t follow you.
    Here’s another way to look at it, however:
    A person choosing between buying today or waiting one year will theoretically save money by waiting. That is, given the above assumptions–which I stress, are just assumptions for illustration purposes.
    This savings will occur regardless of what rates are like at renewal in five years.
    After 2015, the individual faces the same rates, be they higher or lower–regardless of whether they chose to buy now or wait. The key is that they’d be mortgaging less when they come up for renewal because they bought at a 7.5% better price from the get-go.
    One could also wait one year to buy and then take a 4-year term (instead of a 5-year). The renewal date would then lines up in both cases. In that scenario, they’d be even further ahead because they’d pay interest at a lower rate (than a 5-year fixed) until 2015, plus they’d get the 7.5% savings on their purchase price.
    Cheers,
    Rob

  10. Hi David,
    I’d submit that “always” is a bit too categorical a word.
    In actuality, it fully depends on how much lower the price is in one year, and on how much higher the interest rate will go.
    The optimal choice could be completely different if prices declined much less than 7.5% and if different interest rate assumptions were used.
    Cheers,
    Rob

  11. Hi George,
    None taken. :)
    As in the response above to $.02, the savings is locked in before renewal.
    Regardless of which choice the buyer makes (i.e., buy in 2010 or 2011), he/she would hit renewal with a lower principal balance by waiting one year to buy, based on the above hypothetical.
    Again, the point isn’t to scare people from buying. It is just an illustration which addresses a question that many people are asking: buy now or wait. There are a host of other factors to consider (the buyer’s income, assets, down payment, budget, personal preferences, personal expectations, etc.) so the result is by no means applicable to everyone. The concern would be greater for a first-time home buyer with more tentative financial circumstances, than for someone putting down 20% with sizable liquid assets and stable high-income employment.
    Cheers,
    Rob

  12. Hi Nelson,
    A crash would most likely keep rates (and potentially inflation) low.
    A much more modest decline coupled with a strengthening economy/inflation would likely coincide with rising rates.
    Cheers,
    Rob

  13. In addition to Toronto, add: Vancouver, Victoria, Calgary, Edmonton, Regina, Saskatoon, Winnipeg, Montreal, Quebec City, Ottawa, and St. Johns.

  14. House prices are dependent on multiple factors:
    Average Income
    Interest Rates
    Overall Health of Economy
    Employment
    Natural Population Increase
    Inflation
    You are right that house prices have roughly doubled from 1999 to 2010 (http://takloo.wordpress.com/2010/07/09/is-canadas-housing-market-about-to-collapse-us-style/)
    But for the same period:
    Inflation has been 25%… AND more importantly
    Canada’s GDP has roughly increase by 65% (http://www.google.com/publicdata/explore?ds=d5bncppjof8f9_&ctype=l&strail=false&nselm=h&met_y=ny_gdp_mktp_cd&hl=en&dl=en#ctype=l&strail=false&nselm=h&met_y=ny_gdp_mktp_cd&scale_y=lin&ind_y=false&rdim=country&idim=country:CAN&hl=en&dl=en)
    Don’t get me wrong, like I have said before, I am looking to buy a house too and I do think prices will come down… just not crash US style.

  15. I was looking at this and the average wage increase in Canada. There is no relationship whatsoever. The major contributors to the housing cost may be many fold – Partly – immigration is driving House price up. Then may be the low interest rate is also a key player.

  16. Sudip,
    The immigrants keeping house prices up is a myth. For starters, not all immigrants have money. But setting that aside, Toronto, for example, where most immigrants end up, only grows at 0.6% per year. Canadians are simply having fewer kids, and immigration makes good back-fill but not much more. Take a look at our population pyramid… It’s inverting.a

  17. If the increased GDP isn’t reflected in salaries, it’s not doing the housing market any good.
    You can’t buy a house with GDP.

  18. They would also save the money that they would pay in taxes as well as money spent on house upkeep per year (usually 2% price of home). Lastly, people are forgetting the down payment amount being put into a GIC at 3% for 5 years. As Rob says, the situation can completely change based on how much home you are buying, how much interest rates go up and how much prices go down.

  19. For the average working canadian, I agree but real-estate is a major a investment asset class and hence bares no direct correlation to average income… plus the reported income is seldom the real earned income… consider self-employed professionals, immigrants and speculators, etc… GDP at least reflects this income…

  20. I used a fixed downpayment instead of 15% – although if you wait a year you can actually come up with a larger downpayment and maybe go from 15 to 18-20%… at that point you’re probably getting lower monthly payments too.

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