Tailwinds point towards a soft landing

• Tailwinds include low mortgage rates, relatively low unemployment and strong immigration
• Headwinds include high prices, elevated household debt and slowing employment
• More buyers are turning to variable rate mortgages on expectations that rates could stay low for some time, or even decline.
• Average Canadian house prices were a record two-thirds more than average U.S. house prices

TORONTO, September 30, 2011 – After a decade of strong growth in the Canadian housing market, residential real estate is headed for a “soft landing” with prices moderating in the months ahead, according to a Special Report from BMO Economics.

Low interest rates have fuelled Canada’s housing market in the past decade, pushing prices to new highs in most regions. Sales are now close to their past-decade norm, and well below pre- and post-recession peaks, while residential mortgage demand has also moderated. However, a weaker economy and new mortgage rules have dimmed activity recently.

“Since the prudent and timely mortgage rule changes announced early this year by Finance Minister Jim Flaherty, Canadian house prices have moderated,” said Sal Guatieri, Senior Economist and Vice President, BMO Capital Markets. “House price gains are slowing. Although average resale prices rose a brisk 7.7 per cent year-over-year in August, the rate of increase has slowed from nearly 9 per cent earlier this year.”

Mr. Guatieri noted in the report that housing activity should remain moderate in the year ahead, with tailwinds including low mortgage rates, relatively low unemployment and strong immigration. Furthermore, a weak global economy and Europe’s debt crisis will likely keep the Bank of Canada on the sidelines until early 2013, while further easing measures by the Federal Reserve should suppress long-term rates in both countries, thereby supporting affordability.

On the flip side, Mr Guatieri noted that the housing market also faces several challenges, including high prices, elevated household debt and slowing employment.

“Prices have risen twice as fast as incomes in the past decade, lifting the current ratio 16 per cent above its norm. Although the current overvaluation is below levels that triggered price corrections in Canada in 1989 and the U.S. in 2006, it will remain a thorn in the side of first-time buyers,” said Mr. Guatieri. He added that for bargain hunters, Canadian houses, on average, cost a record two-thirds more in local currency terms than properties in the U.S.

The upshot is that home sales are likely to remain steady in 2012 and prices should also stay put. However, the resource-rich provinces, notably Alberta and Saskatchewan, should outperform other regions since their economies are expected to grow the fastest. Because housing is moderately overpriced in most regions (and considerably so in Vancouver), it’s vulnerable to a correction.

“Regardless of the current low interest rates, it is still important for homeowners or potential buyers to be prudent and stress-test their mortgage against a higher interest rate to ensure they can afford what they signed up for. Total housing expenses should not consume more than one-third of total household income,” said Katie Archdekin, Head of Mortgage Products, BMO Bank of Montreal.

Ms. Archdekin added that Canadians need to be continually examining ways to reduce overall housing costs. “BMO has developed products, such as the low rate mortgage with a maximum 25-year amortization, that we believe are directly relevant to today’s environment and specifically designed to help Canadian consumers manage their debt. Furthermore, the lower amortization can significantly reduce the amount of interest paid over the life of the mortgage.”

Additional factors expected to affect the future of Canada’s housing market:

• The biggest threat stems from the perceived one-in-three chance of a recession, and the attendant loss of jobs.
• Another risk, though far smaller, is if interest rates spike higher next year. Even a moderate 2 percentage point increase in rates would severely impact affordability. Low rates are a threat too, since they could cause the market to heat up again, only to correct when rates eventually rise.
• Mortgage growth is expected to moderate as Canadians turn more cautious in managing their debt. Despite slower personal credit growth, household debt hit a record 1½ times disposable income in Q2, as residential mortgages continued to outrun income.
• Meanwhile, job and income growth should moderate next year, as the economy is expected to grow just 1.8 per cent versus about 2.2 per cent this year.
• More buyers are turning to variable rate mortgages on expectations that rates could stay low for some time, or even decline.