Canada's remarkable housing recovery

The signs of economic recovery seem to be everywhere these days. Consumer confidence is up. The governor of the Bank of Canada has all but declared the recession over, with the latest GDP figures suggest that the economy is growing again. The stock market has surged 50 per cent from its March low. Plenty of "green shoots" and all that.

A stunning recovery in the Canadian housing market also appears to be taking hold if anecdotal evidence and the statistics are to be believed. Sales are up by double digits in most major markets across the country (they've more than doubled in Vancouver). Average selling prices have rebounded from just the start of the year and are now at record levels in most provinces. Bidding wars have returned in Vancouver and Toronto.

That's a remarkable turnaround from the situation just eight months ago, when prices were down year-over-year in the more expensive markets and sales slumped more than a third from the previous year's levels. Many homeowners took their properties off the market to wait out the slump, which led to a dearth of listings and helped to stop the slide in prices.

Most economists see this quick bounce-back as surprising but healthy — further proof that Canada and the Canadian consumer weathered the global recession better than our American cousins. But a few observers remain wary of jumping on the housing bandwagon. They point to other statistics — like the country's rising deficit, rising unemployment, rising personal bankruptcy numbers, rising household debt levels, a hobbled manufacturing sector and mortgage rates that have nowhere to go but up.

They see all this as raw material for a looming drop in housing prices that could leave many recent homebuyers who've put five per cent down "under water" — in other words, owing more on their homes than the homes are worth. In some U.S. markets, more than half the homeowners who have mortgages have negative equity.

Former maverick MP, federal cabinet minister and personal finance author Garth Turner is one observer who's firmly in the "bubble" camp. His real estate blog — entitled "Greater Fool" — has been forecasting something approaching a housing meltdown for a while now.

Last winter, Turner predicted the real estate market would wither in the face of the recession. But it didn't — a fact he attributes to low interest rates that encouraged "massive borrowing by people I thought were already hideously indebted." He also blames the real estate industry for "irresponsibly telling people prices would rise forever and [that] they must buy now while rates were low."  

To be sure, most analysts don't see the housing market as being in bubble territory. They argue that homes are much more affordable now than they were during the last major bubble in the late 1980s, when mortgage rates were above 10 per cent. But there's no denying that there's something of a frenzy in some markets these days.

Low rates + confidence = sales

'The max we’ve seen so far this year is 20 offers one evening on a semi-detached home.'—Toronto realtor Thomas Cook

There's widespread agreement that low mortgage rates are spurring the recent buying spree in housing. At the time of writing, a five-year fixed mortgage was available at most major financial institutions at a generational low of 4.19 per cent — even less at a few smaller lenders. That has prompted buyers who had headed to the sidelines late last year to flood back into the market. 

Some times, that flood of buyers is directed at some of the same properties. "The max we've seen so far this year is 20 offers one evening on a semi-detached home," Toronto realtor Thomas Cook wrote in his blog in July.

Some observers also credit a couple of measures introduced in February's federal budget aimed at first-time buyers — a $750 tax credit and an extra $5,000 that buyers can take from their RRSPs for a down payment.

But low interest rates are still the biggest factor. Still, Gregory Klump, chief economist at the Canadian Real Estate Association, says mortgage rates alone weren't enough to push people from browsing to buying. People are now more confident their jobs are safe, he told CBC News.  "Improved affordability combined with improved economic security — that's resulting in the drastic rebound in sales activity," he says.

The Bank of Canada has pledged to keep its key overnight lending rate at a rock-bottom 0.25 per cent until at least the middle of 2010, as long as inflation doesn't pick up. In the short term, there seems little likelihood of that.

Rate hikes to come eventually

But some economists are warning that the central bank may eventually be hiking rates big time. "The tightening will not likely begin before the third quarter of 2010," according to Sébastien Lavoie, an economist at Laurentian Bank Securities.

"That said, when the time does finally come, timid [quarter percentage point] increases will not be enough to 'normalize' rates," he wrote in early September. "The Bank [of Canada's] exceptionally low current policy rate implies that the tightening cycle will have to be quite aggressive." How aggressive? Lavoie forecasts "a succession of hike announcements" of a half, three-quarters and perhaps even a full percentage point at a time.

Increases that large could, of course, play havoc with the real estate market. Those who stretched to buy through a 35-year amortization could find themselves in big trouble when it comes time to renew if rates spike. Given that a recent survey from the Canadian Payroll Association found that 59 per cent of Canadians are living paycheque to paycheque, the prospect of a sharp jump in mortgage costs would hit some owners very hard.

"People need to be circumspect," CREA's Klump agrees. "They need to run through the scenarios. What if rates jump two per cent?"

Do the math

A quick look at the math shows what could happen if rates do jump substantially. Let's assume someone has bought a house for $320,000 — the average national MLS selling price in August. If they put five cent down, they'd face a mortgage of $304,000 plus mortgage loan insurance of $8,360 for a total financing requirement of $312,360.

With a five-year mortgage rate of 4.19 per cent amortized over 35 years, that yields monthly payments of $1,412 month. Jack the rate up to 8.0 per cent, and the monthly payment jumps more than $700 to $2,189.

Rising prices and rising mortgage rates will make it more difficult to carry that home purchase. "If prices continue to eclipse incomes [as they have for seven years], affordability could become an issue again for first-time buyers, especially when interest rates return to more normal levels beyond 2010," warns BMO economist Sal Guatieri.

A variable rate mortgage is now available for as little as prime plus 10 basis points (2.35 per cent) — a big improvement from the prime plus one per cent that was offered earlier this year. At MonsterMortgage.ca, vice-president Vince Gaetano tells CBC News the majority of clients at his firm are going variable, with about 35 per cent choosing a five-year fixed mortgage.

He notes that most bankers last year were predicting rates would jump — warnings that led many who had been enjoying variable rates as low as 1.45 per cent to lock in for five years at rates above five per cent. Needless to say, he doesn't think much of bank prognostications.

Will recovery stall?

While bidding wars have returned in a few markets, a better balance between supply and demand could be in store as more listings appear. Nationally, average selling prices in August were up 11.3 per cent from the previous year to $324,000. But realtors say that average is skewed upwards by more sales of expensive homes in the more expensive markets (for instance, Calgary saw one home sell for $10.3 million in August).

CREA says factoring out changes in sales activity results in a year-over-year weighted price increase of 7.1 per cent. The weighted August figure was actually down 0.8 per cent from July.

In the short term, most observers think the recovery in Canadian housing sales will continue as mortgage rates stay historically low and more listings appear. Longer term, there's more uncertainty. The real estate industry sees national sales rising 5.3 per cent in 2010 and average home prices rising modestly — up 2.1 per cent over 2009. CMHC predicts an average price increase of 1.6 per cent.

Others are more cautious. A recent survey by Royal LePage of more than 1,100 of its agents found only 61 per cent  thought the housing market's current strength was sustainable. The biggest reason cited by the doubters was the expectation that mortgage rates will rise.

Real estate watchers are advising borrowers to be careful in the current low mortgage rate environment and add some wiggle room to their affordability calculations. Rates are bound to go up at some point — the only question is when and how fast.