Reflections on the Canadian House Price Boom
My colleague David Williams recently blogged about the stupendous build-up of private sector debt in Canada, China and several other countries over the last decade. The contemporaneous and closely linked Canadian housing boom also warrants attention, particularly as a long period of unusually-low borrowing costs comes to an end.
As the Organization for Economic Cooperation and Development (OECD) noted in its latest report on Canada, house prices, nationally, more than doubled in inflation-adjusted terms between 2000 and 2017, far outpacing the growth of incomes and rents (see Figure 1 below). By the fourth quarter of 2017, the ratio of average house prices to incomes was at a record high (Figure 2). House price increases have been most dramatic in large urban centres, notably Metro Vancouver and Greater Toronto, but price escalation was not exclusive to the biggest cities. That said, Vancouver and Toronto stand out among all OECD metropolitan regions for having high median house prices relative to median incomes (Figure 3).[1]
Figure 1
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| Source: OECD Economic Surveys: Canada 2018. |
Figure 2
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| The chart shows the deviation of the latest observation from the long-term average. Source: OECD Economic Surveys: Canada 2018. |
Figure 3
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| * Includes Gatineau Source: OECD Economic Surveys: Canada 2018. |
Canadian house prices since the mid-2000s have been buoyed by incredible strength in demand due to ever-lower mortage interest rates, generous access to leverage for uninsured and insured buyers, and high wealth-based migration and capital inflows from China into the land-constrained gateway cities of Vancouver and Toronto. These factors do not appear to be stimulating demand anymore. Global interest rates are rising. Governments are tightening credit rules in Canada and China. Non-resident property owners are facing more hurdles to parking their capital in Canadian real estate. Looking ahead, it is hard to imagine that Canadian house prices will continue to rise significantly faster than overall inflation and incomes. An extended period of weaker real Canadian house prices seems probable.
Also worth noting is that total household debt has risen steeply in Canada, reaching 170% of disposable income in Q4 of 2017, an unprecedented level that puts Canada in the upper quadrant among all advanced economies (Figure 4). The debt-to-income ratio, like the ratio of median house prices to median incomes, cannot continue to climb indefinitely. Moreover, the Bank of Canada has raised interest rates four times in one year. The full effect on household balance sheets will be felt as Canadians progressively refinance their mortgages over the next five years.
Figure 4
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| Source: OECD Economic Surveys: Canada 2018. |
A third factor that heralds softening house prices is the suite of measures introduced by the federal and some provincial governments to discourage foreign home-buyers, dampen short-term speculative activity, tighten uninsured mortgage financing rules, and step up efforts to tackle tax evasion, mortgage fraud and money laundering in the residential real estate sector. Perhaps more significantly, China has imposed a raft of regulatory measures to cool its incredible housing and private credit boom (seen by many analysts as a "bubble"). The Chinese government has also taken steps to more vigilantly enforce restrictions on capital outflows. The latter may affect the ability of China's rapidly growing cohort of high-wealth individuals to park capital in offshore real estate.
Financial products often include a warning that past returns are no guarantee of future returns. People looking to purchase a home would be wise to assume that the massive house price appreciation seen in Canada since 2000 will not be repeated in the coming years.
[1] Note that a drawback to using the house price to income metric is that house prices are not only driven by incomes. House prices are also driven by (on the demand side) changes in real and nominal mortgage interest rates, access to credit, capital gains expectations and investor demand from domestic and foreign buyers; and (on the supply side) long-term growth in the housing stock. Mullbauer, St-Amant and Williams (2017) disaggregates the contributions from each of these factors to long term changes in Canadian house prices.