Real estate reality check: How much home can Canadians handle?
In Altadore, a pine-speckled neighbourhood that borders lush parkland along the Elbow River in southwest Calgary, the average house now costs $360,000 more than it did eight years ago.
Between 2005 and the end of last year, prices in Altadore rose 78 percent as squat post-war bungalows were bulldozed and replaced with high-end multiplexes and two-storey homes, inhabited by urban professionals working in gleaming office towers a few kilometres away in Calgary’s downtown core.
“I think anybody who lives here is absolutely astounded by how quickly property values have moved up,” says 34-year-old Thomas Ferianec, who has lived in the neighbourhood since 2008.
Cheap and readily available home loans have stoked a historic borrowing boom, propelling Canadian residential real-estate values to new – and, to some, precarious – heights.
It’s true that Canadian households have never been worth more. They’ve also never been deeper in debt, 70 per cent of which is money owed on mortgages.
In depth: Paying for Canada’s housing boom
In the past several years, the gulf between incomes and house values has widened. The ratio of what you owe to what you earn now matches that of U.S. households before the 2008 housing bust.
Should we be worried? Are Canadians riding a similar credit-driven asset bubble?
Canadian realtors say no.
“It’s a mistake to think that what happened in the U.S. will happen in Canada,” Canadian Real Estate Association head economist Gregory Klump told The Financial Times this month. The FT is one of several foreign news outlets – including the New York Times, The Economist, and CNBC – that have taken notice of Canada’s frothy market.
“There was a lowering of credit quality in the U.S. that has not happened in Canada,” Klump said. “If anything, over the past four years tightened mortgage regulations have successfully prevented a housing bubble.”
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If Klump and those who share his view are right, Canada will have achieved something the U.S., Ireland and other countries that experienced overheated, highly leveraged housing markets couldn’t: A soft landing.
The pace of home sales this year doesn’t suggest a graceful deceleration. If anything, with the exception of October, the market has been regaining momentum – with growth strongest in Vancouver, Toronto, Calgary and Edmonton, according to TD Economics.
That resurgence after a spring lull has pushed household debt levels to a fresh high of $1.63 for each dollar brought home in after-tax income. $1.05 of that is mortgage debt.
Seven years ago, Canada’s debt-to-income ratio was $1.38. It now sits right where U.S. debt levels were just before the recession.
Some point out the comparison’s imperfect at best: Disposable income’s calculated differently on either side of the border.
Others argue that, no matter how you slice it, Canadian debt levels have surged even as much of the rest of the world paid down debt.
“The Canadian consumer has not deleveraged,” says Andrew Jennings, chief analytics officer for Fico. The a U.S.-based company tracks debt levels for credit agencies and banks, including Canada’s major lenders.
“There’s arguments about how you compare one to the other because the statistics are not exactly calculated in the same way, but when you look at the Canadian statistics, they continue to rise,” Jennings said.
Despite comments from Governor Stephen Poloz this month that a bubble isn’t forming, the Bank of Canada appears increasingly uneasy.
“The elevated level of household debt and stretched valuations in segments of the housing market remain an important downside risk to the Canadian economy,” the country’s central bank said in its most recent economic report.
When your home costs 10 times your paycheque
There’s a multitude of metrics to determine whether homeowners are in over their heads. But“it doesn’t matter which you use, they all tell the same message,” says David Madani, chief economist at Toronto-based Capital Economics: “Housing in major markets across Canada is substantially overvalued.”
The debt-fueled explosion in home prices over the last decade has lapped inflation and income growth several times over, Madani and others note.
“Historically it differs from market to market, but roughly [the price of a house] has always sort of been three or four times income,” Madani said. “In Vancouver, we’ve seen now where house prices are ten times income for the average household. When you’re looking at a market that’s ten times income, that’s just ridiculous.”
The median price of any type of house in Vancouver two years ago was about $700,000, up 63 per cent since 2005. Median income for a working-age family sat at $79,200 – up 14 per cent in that same time period.
In Toronto, the country’s second-priciest market, the median price of a home (across all housing types) was about $399,000 in 2011 – roughly five times a working-age family’s average annual income. But that ratio’s far higher if you’re looking for a single-family home.
READ MORE: House-hunting in Toronto’s hot market
“That’s what we’re looking at when we say housing in major markets across Canada is substantially overvalued,” Madani said.
A recent report from U.S.-based urban development consultancy Demographia finds it’s harder to buy a home no matter where you live in Canada.
Regional differences aside, the average homeowning Canadian household forks over 42.7 per cent of its income to pay the carrying costs (mortgage, utilities, property tax) on its home, according to the Royal Bank of Canada. The bank’s third-quarter affordability reading, due out in weeks, is expected to show that percentage growing.
The rule of thumb among mortgage brokers is that no more than a third of your pre-tax income be spent on the carrying costs of your home.
As long as interest rates remain at historic lows Canadians are being reassured they’ll still be able to service outsized loans and avoid losing their homes.
People worried about Canadian debt levels aren’t taking into account “the effect of exceptionally low interest rates,” says Robert Hogue, senior economist at RBC. “In terms of mortgage debt servicing, it may be a little on the high side but not concerningly so.”
While recent developments point toward ultra-low rates sticking around for some time to come, housing market bears such as Capital Economics predict a price correction in the order of 25 percent if rates move too high too suddenly. A swing of a couple of percentage points would add hundreds of dollars a month in additional mortgage interest for many recent home buyers.
Affordability calculator: How much house can you handle?
Depending on broader economic growth, some expect rates to rise by 2.0 percent by 2015 beginning next year.
That kind of interest rate increase could make Canadians house poor and put a severe chill on the market. Worse, home owners unable to keep pace with payments may be forced to sell into a declining marketplace.
The hope is that Canadians can get the debt around their necks in check before rates rise.
“It’s not the number of houses changing hands in a given month that is of concern,” CIBC chief economist Avery Shenfeld said in a note last month. “But whether the size of each mortgage being issued lines up with the borrower’s ability to pay at current and future interest rates.”
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