Home prices can't keep increasing, despite low interest rate environment

TORONTO - Canadian home prices spiked unexpectedly by as much as 7.8 per cent in the most recent quarter, but such dramatic increases aren't likely to last, according to a housing report released Wednesday.

The Royal LePage House Price Survey warned that the average price for a Canadian house in the third quarter was driven higher by the effect of expensive cities like Vancouver and Toronto, overshadowing the fact that price increases slowed and values even fell in some areas.

It found the national average price of a detached bungalow rose 7.8 per cent year-over-year to $349,974. The standard two-storey home rose 7.7 per cent to $388,218 and standard condominiums rose 5.7 per cent to $239,300.

"A resilient domestic economy coupled with the stimulative effect of ultra-low interest rates has extended the post-recession bounce in house prices, but there is evidence of overshooting in some markets," said Phil Soper, president and chief executive of Royal LePage Real Estate Services.

Bank of Montreal senior economist Benjamin Reitzes said he believes that the current values of Canadian homes can't be sustained, but neither will they take a huge drop.

That's because housing demand has been largely exhausted after two years of low interest rates and many Canadians have already accrued too much debt during and since the recession. He expects demand to drop off slightly, but the market to remain healthy as long as interest rates stay low.

"There's little to provide much lift to the housing market, but there's not much to drag it down either," said Reitzes.

The International Monetary Fund sounded a more pessimistic note Wednesday, warning that Canadian household debt is too high and that could spell trouble for the economy, especially if housing prices do drop and further reduce Canadians' net worth.

"Consumption might moderate more than expected from a large retrenchment in highly indebted households amid concerns of a drop in house prices," it said in its most recent economic outlook for the Western Hemisphere.

"The latter are estimated to be above levels dictated by economic fundamentals in some key provinces."

It said that a weak outlook for the global economy means interest rates are expected to remain low well into 2013 and projected a small rate cut "in the near-term."

That's good news for homeowners with mortgages and consumers financing loans and lines of credit.

As long as rates remain low, home buyers are able afford a bigger mortgage with monthly payments the same as they would be with a smaller mortgage and higher interest rates.

For example, the monthly cost of carrying a five-year $300,000 mortgage for 30 years at a three per cent variable rate would be about $1,264. In 2007, when the housing market was in a pre-recession boom and five-year variable rates were as high as six per cent, that mortgage would cost 30 per cent higher each month, at $1,799.

But interest rates can't fall much lower than the present one per cent, Reitzes noted, and a real jump in job growth that would encourage home upgrades isn't likely to happen in the next year or two.

"I don't know if low rates are going to push people to jump in, you've probably already got a lot of that," he said.

"But it will keep prices from coming down... it's going to provide underlying support, so even though the economy is not growing very strongly, housing could remain relatively healthy and sales could stay flat or decline slightly."

Home prices have stayed higher for longer than economists expected, largely because they believed interest rates would rise sooner. Some have warned that a major correction in Canada's housing market — even a U.S. style crash — is possible.

Home values have been driven up by the belief that prices will continue to increase, but that psychology is at odds with the fact that household incomes are stagnant and consumer confidence is waning.

But many economists say Canadian prices are likely to flatten over the next few years, rather than undergo a dramatic drop.

"Although some commentators are predicting that the sky will fall on the Canadian housing market in a U.S.-style implosion, we lack the structural conditions that precipitated the housing crash in the United States six years ago,” Soper said.

The U.S. housing market took a huge dive in 2009 amid the widespread mortgage and foreclosure crisis.

Finance Minister Jim Flaherty told a business audience Wednesday in New York that unlike the U.S., Canada has a strong housing market thanks to "prudent lending practices" by the country's banks.

Canadian banks avoided the sub-prime mortgage lending mess that battered the American housing market and continues to keep housing prices depressed and foreclosures high in the United States.

Last year, the federal government tightened bank lending rules making it harder for consumers and property owners to borrow large amounts without a bigger down payment.

Canadian home prices varied widely in the third quarter, depending on the local market. For instance, detached bungalows in Vancouver had an average price of about $1 million — nearly three times the national average.

The Canadian national price of a standard two-storey detached home rose 7.7 per cent to $388,218 and the price of a standard condominium 5.7 per cent to $239,300.

In Vancouver, usually the country's most expensive real-estate market, the average price for a two-storey homes was $1.14 million and condos were going for about $513,500.

The report highlighted both Calgary and Edmonton as regions where prices were relatively flat year-over-year.

In Toronto, prices were up for all housing types surveyed. The average price for detached bungalows was $518,433, up 9.4 per cent from a year earlier. Standard two-storey homes were up 7.6 per cent from a year earlier to $620,862.

In Atlantic Canada both Halifax surged ahead with the price of standard condominiums increasing 10.4 per cent.