BMO: Home Prices May Deflate But Likely Won’t Pop

inflated-housing-marketCanada’s housing market is more like a balloon than a bubble, writes BMO Capital Markets in this report.

It should “deflate slowly” in the absence of a “pin.”

That “pin” (catalyst) could be one of the following, says BMO (our comments in italics):

  • An approximately 400 bps increase in mortgage rates (BMO’s Sal Guatieri told CBC today: “We tend to rule out that shock.” But his report notes “Even a moderate two-percentage-point increase to more normal levels would put some strain on affordability and slow the market.”)
  • Major job losses
    (BMO is talking on the order of 400,000+. It adds: “Unless Europe’s credit crisis worsens materially, a recession is not in the cards given current low interest rates.”)

  • A re-acceleration of home prices and mortgage borrowing
    (especially without corresponding income gains)
  • A halt or reversal in foreign investment
    (BMO says: “…Due to a lack of data, no one knows for certain how large a factor this has been.”)

BMO shares some other notable stats as well:

  • “Average prices have grown more than twice as fast as family incomes since 2001.”
  • “…Elevated price-to-income ratios do exist in four major cities: Vancouver, Victoria, Toronto and Montreal.”
  • “…The typical homebuyer still spends just over one-third of disposable income on mortgage payments, a share that’s just modestly above long-term norms.” (As a rough rule of thumb, for every 1% rates rise, mortgage affordability drops by 9%—assuming other factors [like income] are held equal.)


(Chart Source: BMO; Click to enlarge)

  • “The homeownership rate has climbed about four percentage points in the past decade to around 70%”
  • “Delinquency rates have remained very low even in periods of deep recession and financial turmoil” (including double-digit mortgage rates and unemployment in the early 90s)
  • “Low interest rates should hold affordability in check for some time, allowing incomes to catch up with higher prices” (that’s speculation of course)
  • “…About half of all new condos in the GTA are purchased by investors.” (GTA and GVA vacancy rates are miniscule [near 1%])
  • “As interest rates rise, most homeowners with variable rates will lock in at still very low borrowing costs.”

BMO concludes, “…The national housing market appears somewhat pricey, but is far removed from bubble territory.” BMO uses the word “national” because that statement does not apply everywhere.

Rob McLister, CMT

  1. (GTA and GVA vacancy rates are miniscule [near 1%])
    I think it’s worth mentioning the caveats that go along with those widely-quoted “miniscule” vacancy rates (which come from the CMHC Fall 2011 survey), and what they may mean for the condo market.
    (1) The number refers to actual vacancy (a vacant unit ready for immediate occupancy on the day of the survey). The availability rate (where the previous tenant has given notice and is scheduled to move out, but the apartment is not yet physically vacant) is about 2x the vacancy rate.
    (2) CMHC’s data comes from in-person and telephone surveys of landlords (voluntary disclosure).
    (3) CMHC only surveys buildings with three or more rental units. Basement apartments, duplexes, and rental houses are not included in the CMHC’s stats. It’s basically only four-plexes on up.
    (4) The survey is conducted in late October over a two-week period, and reflects that time period only.
    An additional point worth mentioning is that even if vacancy is low, it doesn’t necessarily mean that condo investors are making money (positive cash flow). The stats from Urbanation — 2010-2011 new condo prices per sq ft increased seven times faster than condo rents per sq ft — would seem to indicate that it’s getting increasingly difficult to derive income from a rental condo in Toronto, unless you got in very early or made a huge down-payment. The anecdotes going around would seem to back this up too.
    IANA broker, realtor, or economist, just someone very interested in what is going on and quite fearful for what will happen to the local economy if (when) the condo market tanks.

  2. @Joe Q.
    I think it’s more about relative numbers. Vacancy in core Toronto is less than 1/3 the national average. That is tight no matter how you break it down. Compare to places like Windsor (8.1%), Abbotsford (6.7%) and Saint John (5.9%).

  3. I agree, but I think the most relevant numbers would be longitudinal rather than lateral. How has the vacancy rate (measured the exact same way, i.e. mostly high-rises only) actually changed over the last 10 years?

  4. Wow, that’s a really interesting graph showing affordability. Last time the bubble burst (late 80s), we were at 53% of household income. Before the BoC started lowering rates around 2007, we were at 47%. So… since home prices (and thus mortgages) have increased over the last 5 years, and interest rates have plummeted, is it safe to assume we’re probably over the 50% mark for % of household income required in terms of an ‘actual’ interest rate? (actual meaning the prevailing rate once today’s artificially lowered rates go back up, lets say in 2014)

  5. What about the “pin” of simply pricing enough people out of the market?
    Isn’t there a point where prices get so high the market simply barfs?

  6. I would say that a change in the CMHC’s amortization or down-payment rules would be a very effective “pin”.

  7. I think by definition a “pin” is something that acts very quickly. Pricing certainly goes up and down but it is a relatively gradual process (months and years as opposed to days).

  8. Certain markets are there already. Victoria has been flat for almost 4 years now. The ceiling here seems to be about $630k no matter what happens to interest rates.

  9. I’d like to see the BoC rate shown on the same graph to see how affordability compares to the prevailing mortgage rate. It would be nice to compare one to the other. In the late 80’s, we had high rates that definitely affected affordability; but was it a lagging impact or leading? What exactly is the relationship between rates and affordability?
    The experts were talking about the ‘pop’ last year but the sellers parked their inventory and waited. So the ‘pop’ never occurred. Will they remain parked this year? I don’t think anyone can tell us that yet.

  10. I really watch and make my own point,
    The article did not tell when interest rates will go up, I see that it is in hold or a very near cut, FED down the border got it fixed till end of 2014, the global crisis may extend till 2017 before a recovery is felt. BOC is not showing any signals of rate hike, and this how it is going around the developed world.
    Guys we are in recession but the Canadian economy is weathering it nicely, that is why housing market is holding up, and it will as more new self-employed immigrants are into the country, they move into rentals and then they look for better and buy houses, that will push market up, but rates will be kept down till 2014

  11. The market depends of 2 things – prices and the wealth of the buyers.
    Immigrants and youth are a major divers in this process as first time buyers.
    So anything that affects their affordability will affect the market.

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