Bruce & Patricia Williams Sales Representatives

The national average home price was down in March from where it stood last year. But home prices are not declining. Confused?

Average prices are affected by changes in the mix of sales, so year-over-year price comparisons can be like looking in a funhouse mirror: distorted.

To illustrate: line up a class of kids by height, calculate the average. Now excuse the ten tallest kids and recalculate the average. The average height has declined, but the kids haven't gotten any shorter.

A year ago, the national average price was pitched up by surging sales activity in some of Vancouver's priciest neighbourhoods. With activity there having subsequently returned to earth, the average has declined.

By contrast, the MLS^® Home Price Index (HPI) is not affected by changes in the mix of sales. It's based on a sophisticated model of buyers' willingness to pay for various features that contribute to a home's value, and provides a clear picture of home price trends. The MLS^® HPI remains up from year-ago levels, so the reality is that home prices are still climbing in the five major markets that it currently covers. That includes Vancouver, where the average price was down from where it stood last year.

Price gains have remained strongest in Toronto since mid-2011. The rise in Toronto’s Composite MLS® HPI was a full two per cent above the year-over-year increase in Vancouver’s composite index. This represents the largest spread for price growth between these two markets in more than a year. This gap may widen further, since the Vancouver market is showing signs of coming off the boil while a lack of available supply relative to demand keeps Toronto’s housing market in seller’s market territory.

Stricter mortgage insurance rules have taken some steam out of the Canadian housing market. Home sales fell 0.5% in August, a fifth contraction in the past seven months, while home price pressures eased. However, the impact has not been overly dramatic and the level of housing activity remains healthy.  Shaky consumer confidence will likely weigh on the housing market in the near term. However, a continued low interest rate environment will likely help support a modest pick up in housing demand in early 2012. 

Through the last three and a half years of global economic gloom, the strength of the Canadian housing market has been a symbol of Canada’s relative outperformance. While many other advanced economies were bogged down by a large scale housing correction, the Canadian housing market continued to surprise on the upside. Amid fears that the housing market was overheating in a highly stimulative interest rate environment, the federal government announced stricter CMHC mortgage insurance rules in early 2011. Indeed, tighter government regulation has since skimmed some of the froth off existing home sales and price growth. The number of homes sold in August was down 5.5% from levels at the start of the year, while home price pressures have begun to ease. However, the impact has not been overly dramatic and the level of housing activity remains healthy, with 70% of Canadian markets in balanced territory. Meanwhile, certain segments of the market, such as Toronto and Vancouver, remain hot relative to domestic fundamentals. Overall, TD still judges that Canadian home prices are roughly 10 to 15% overvalued.

Going forward, TD Economics expects an orderly cooling to continue through the second half of 2011 as recent financial market turbulence and growing unease over the economic outlook likely weigh on households’ decisions to spend on big-ticket items, such as the purchase of a home. But, a housing slowdown will likely prove short-lived. With a myriad of global economic risks expected to also keep the Bank of Canada from raising rates until early 2013, the interest rate environment is likely to remain extremely supportive of housing demand over the next two years.

As such, once confidence starts to firm up by early 2012, we expect housing activity to pick up modestly. TD Economics continues to believe a 10% correction in Canadian home prices will occur, but this will likely be a story for 2013, when interest rates start to normalize.

A consequence of a strong housing demand has been excessive household debt accumulation. This week we learned that household debt rose to a new high of 149% of personal disposable income in the second quarter of 2011, well above the 140% we deem to be consistent with underlying household fundamentals. The ratio may flatten out in the near term as households borrow cautiously amid economic concerns. However, the key implication of a lower-for-longer interest rate environment, and the resulting elevated level of housing demand is that the Canadian household debt-to-income ratio is likely to rise above 150%. For now, low interest rates will allow households to comfortably carry high debt levels. In fact, the interest costs of carrying debt as a share of income remain low. But, further debt accumulation will only increase households’ vulnerability to the future rise in interest rates. As such, once interest rates begin to rise in early 2013, the level of debt will act as a significant constraint to household spending.

In sum, we expect the household sector to continue to help propel economic growth amid slowing global demand in 2012. However, the consequence is that high household debt levels will weigh on growth beyond that in an environment where interest rates return to more normal levels.

The Government announced some adjustments to the rules for mortgages as follows:

• Reduced the maximum amortization period to 30 years from 35 years for new mortgages.
• Lower the Maximum amount Canadians can borrow in refinancing their mortgages to 85% from 90% of the value of their homes. This will promote saving through home ownership and limit the repackaging of consumer debt into mortgages guaranteed by taxpayers.
• Withdraw government insurance backing on lines of credit secured by homes, such as home equity lines of credit, or HELOC's. This will ensure that risks associated with consumer debt products used to borrow funds unrelated to house purchases are managed by the financial institutions and not borne by taxpayers.