Housing: No Bubble, Just Pricey, Says BMO

No-Bubble-Says-BMOClaims that Canada’s housing market is ready to pop are exaggerated, say economists at BMO Nesbitt Burns.

Instead, they say the market can more realistically be labelled “moderately overvalued” based upon a comparison of house prices with personal income.

They also note that mortgage servicing costs for “typical” homebuyers are running near the long-term norm of 34%.

“Barring a sharp spike in mortgage rates or a relapse into recession, a substantial price correction is unlikely to occur,” economists Earl Sweet and Sal Guatieri wrote in their research report.

They noted, however, that Canadians would have a hard time dealing with a sudden 3% hike in mortgage rates. That would weaken affordability “substantially” and in turn drive down demand and home prices.

They downplayed this risk, though, pointing to the prevalence of fixed rates in mortgage financing, which reduce fluctuations in borrowing costs.

Sweet and Guatieri also predict the normalization of interest rates could take several years yet, with Canadian rates rising 2 to 3 points in that time. They believe incomes should catch up to prices by then.

More worrisome, they argue, is prolonged low interest rates, which could “recharge the housing market and inflate a true bubble that ultimately bursts when rates normalize.”


By Steve Huebl, CMT

  1. So, if Ontario as a whole is about 10% over-valued, wouldn’t that mean that Toronto is above that percentage, and places like Hamilton or Windsor are below?
    Also — as the charts show, the housing market is just like any other market in that it almost never corrects exactly to the “right” level. There is typically an overshoot in either direction. So, if we’re on average 10% over right now, the “correction” would likely hit 10% under. For a place like Vancouver (which is noted as at least 17% over-valued), that could mean a 34% swing to -17% on the downside… this would wipe out many of the 5% down crowd.

  2. Once again….do you care to comment on the analysis over at Financial Insights where they dismantle this ‘report’ and explain why Canadian banks have to lie through their teeth?
    http://financialinsights.wordpress.com/2010/11/04/bmos-outlook-for-north-america/
    http://financialinsights.wordpress.com/2010/10/27/why-the-big-banks-have-to-lie-through-their-teeth/
    It would be nice to se some balanced, meaningful analysis from this site rather than just regurgitating these questionably biased reports.

  3. Pretty hard to see this report as unbiased. Aren’t they in the business of selling loans for houses?
    Aren’t they the biggest lender?
    I think the lesson is that you shouldn’t information put up by the seller.

  4. If you want to read strictly “WE ARE IN A BIGGEST BUBBLE OF ALL TIME” reports, go to http://www.greaterfool.ca and fill your shorts.
    This report is just as well researched as any other report out there. It is done strictly by the numbers…. ie. no emotion like you seem to have way to much of.
    Take a pill buddy

  5. The above post was written in response to The One, but after reading Chris L’s comment I guess it goes for both of ya.

  6. Did you even read the links I provided. Funny how you can look at ‘just the numbers’ but come to completely different conclusions.
    If you’re going to read every report from a bank and take it at face value, you’ll end up with a fish hook in the mouth.
    Think critically man!

  7. Hi ‘The One’
    Thanks for the post. I get the sense you’re a relatively new reader. If you had been following for a while you’d note that there are some stories which are heavily dissected. Other times, due to time limitations, a story is encapsulated for timely news dissemination and further discussion in the forums. In those cases, we convey the information so folks can draw their own conclusions.
    In any case, you’re always welcome to comment and raise counterpoints. That’s the intention of these forums.
    All the best,
    Rob

  8. The One,
    To be fair, the “numbers” examined by your site and by BMO are not identical.
    Your site tends to look at Home Price:Income irrespective of interest rates to point out that people currently spend a higher % of their income on their purchase price than they have in the past. Fair enough.
    In contrast, the BMO report specifically noted that: “… the fair value derived from the long-run price-to-income ratio for housing can no more be considered in isolation of interest rates than can the fair value derived from the trend price-to earnings ratio for equities.”
    In other words, they also looked at Mortgage Carrying Costs:Income as a complementary measure to note that people are not actually spending all that much more of their monthly income on housing than they have in the past because interest rates are currently much lower than they were in the past.
    Both methods have their advantages/disadvantages. And both reports note that large/fast jumps in interest rates would be trouble.
    I tend to side with BMO on the potential for a huge correction (i.e., bubble).

  9. “I tend to side with BMO on the potential for a huge correction”
    I guess this means that you expect mortgage rates to remain at all-time lows throughout the duration of these 25-, 30-, and 35-year mortgages people are signing up for?
    (or, at least, the increase in mortgage payments to be offset by rising incomes?)

  10. Well, Stats, that’s a superficial analysis. Really? You really think that the *only* way a housing crash can be averted is to maintain ultra low interest rates? And, for some reason you think that this must be what I think? Based on what, exactly?
    I expect that *most* (not all, obviously) people are, in fact, taking advantage of current low mortgage rates to pay off large amounts of mortgage principal (as opposed to most of the mortgage payment going towards interest in a higher interest rate environments), so that when they renegotiate at higher rates in 5 years time they will not be overextended.
    I have yet to see any convincing data to support the assumption of impending widespread deflation or the assumption that low interest rates have caused a mad rush of undisciplined borrowing.
    Simply pointing to high rates of borrowing is not proof that such borrowing is inherently bad or poorly considered. If you are going to borrow money, it makes perfect sense to do it when rates are low, rather than rates are high.
    Even Garth Turner, bubble prognosticator, suggests borrowing money now for investment purposes.
    I have no doubt that there are people out there who have overextended themselves and will face huge trouble when rates rise. But I have not seen any evidence that this represents an atypically large segment of the population

  11. Mortgage rates have risen over 3% before and the world didn’t end. The market sells off 10-15% and life goes on. You can’t expect housing to climb in a straight line forever.
    Remember that there have always been people who can’t afford their payments. Obviously higher rates impact them but they are a small portion of the population. I have seen no evidence that this portion is growing abnormally large.

  12. I read the links. Would probably make sense to the uninformed.
    PS: Critical thinkers don’t have predefined conclusions. Get it. You don’t seem to have any….NOT.

  13. I was referring more to the idea of using carrying costs / income (instead of purchase price / income) as a measure of whether or not house are over-valued.
    My point was: if a house is “fairly valued” based on carrying costs at today’s rates, then doesn’t that assume the costs stay constant (or, at least, in-line with income increases)?
    If rates are 2% today, and therefore I can carry a $500,000 mortgage at about $2100/month (25-yr amort), even a small change to 4% would change the mortgage to $2,600/month (24% higher).
    So, I guess my issue is that these calculations are based on a snapshot of where mortgage rates are today, and not on any kind of projection that would try and average that out over the life of the mortgage.
    We are at an all-time low for mortgage rates, so the “average” rate over a 25-yr term would seemingly have to be higher.
    At the end of the day, these “affordability” calculations are only valid until rates change — which can happen several times per year.

  14. A time will come when prices fall enough to put 5% down people under water (equity-wise). Most of those people will just have to wait it out. There isn’t much more you can do if you owe more than your property value. My advice would be, if you buy a home with 5% down, make sure you REALLY like it and wouldn’t mind living there for 10 years. :)

  15. I took a look at both links that your provided.
    1: BMO Outlook for North America, just quotes the BMO report itself, and then provides a link of reference to its own website. The article also accuses everyone in the industry of lying e.g. “‘Subdued’ housing market is banker speak for ‘correction’. Remember, they can’t possibly tell the truth when it comes to real estate.” (The last sentence linking to the second link you provided. Once again, a link to the same webpage.)
    2: “Why banks lie through their teeth.” Besides drawing some graphs as to why banks “lie”, which are based on USA data, I would never trust the analysis of a site that ends its analysis by saying
    “Keep the BS detector cranked up! You’ll need it to help dodge the media and bank-flung cow patties as things continue to unfold.”
    Your links are, just to speak frankly, are gibberish and trash. Relying on pseudo-statistics from the US, and the doom and gloom perspective of pessimistic nay sayers. All summed up by inferring that everyone else is wrong, and your’re right. Please stop peddling this hacked eye insight as anything other than idle banter.

  16. Hence, the following paragraph from the BMO report
    Because of historically low mortgage rates, affordability remains reasonable today. Even with the notable rise in house prices during the past few years, mortgage service costs (including principal) for typical buyers of an average-priced house, are running close to long-term norms of 34%.

      True, if mortgage rates shot up three percentage points overnight, affordability would weaken substantially, and demand and prices would likely fall too.

    However, given the importance of fixedterm loans in the financing of mortgages, average borrowing costs do not fluctuate as much as market rates (Chart 1). Even when market rates normalize, average borrowing costs are unlikely to escalate materially from current levels as more customers lock into fixed-term contracts at relatively low rates. In addition, given
    substantial excess capacity, mild inflation and weak economic recoveries in the advanced nations, the normalization of interest rates could take several years, with Canadian interest rates rising a moderate 2-to-3 percentage points. By then, incomes
    should catch up to prices.

    I think you above arguement is covered in the report.

  17. So, the market is safe because 60%-70% of mortgage-holders have 5-yr fixed mortgages?
    2 problems here:
    1) It’s not like people won’t have issues when that renewal comes due (even if it is 5 years out).
    2) If you need to sell, all that matters is the rate that the buyer is getting, not what you locked into when you bought.

  18. Your logic is flawed, even if the forecast you made is right.
    Try to move to Windsor, and get a job there. Comparing Windsor to Toronto, just because they are both in the same province, is like comparing Mexico to the US just because they are both in North America.

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