Interest rates are finally rising. So where’s the housing crash?—Duncan Hood

 

When did you say that housing crash was coming? Here at Canadian Business, we’ve been predicting such an implosion for some time. Not for months, but—going by past covers—for years. And finally, after all the hysterical headlines, mortgage rates are finally edging up. So where’s the crash?

That’s the gist of a few letters I’ve received lately, and I think they warrant a response. Have we been needlessly keeping homeowners up at night just to sell magazines? The truth is, we haven’t. I still believe a housing correction is on the way, although I also think that Jim Flaherty’s efforts to avoid calamity have been effective so far.

First, though, let’s revisit why we believe housing in Canada is overvalued in the first place. There are two simple ways to measure house prices. One is to assess affordability by comparing average house prices to disposable income levels. The idea is that if no one can afford to buy a home, no one will. By this measure, most economists have found that Canadian homes are less affordable now than they’ve been since the mid-1990s. Some are not alarmed by this (RBC puts us in a period of “mild affordability stress”), but other are. A recent report in The Economist shows that Canadian homes are more overvalued than those in every country in the world except for France.

The second method for measuring whether house prices are inflated is to compare prices to rents. If the monthly carrying cost of buying a house is much higher than the cost of renting an equivalent house, then the price is too high. After all, why buy when you can rent for less? By this measure, The Economist finds that Canadian home prices are more overvalued than every other region they have data for except Hong Kong.

Here at CB we have consistently predicted that house prices will fall when interest rates go up, as that would result in higher monthly payments. Lately, mortgage rates have begun to stir, but they are not affecting anyone’s cash flow yet. In Canada, the overnight rate is still stuck at 1%. If anything, there’s more of a threat of higher rates right now, which has kicked off a bit of a run on house-buying as folks try to get in before the rates go up.

The good news is that homeowners are still fearful. It’s good because if we see a threat coming, we can act. And that’s exactly what our finance minister has done. Flaherty realized some time ago that a housing crash in Canada was a real risk, but we couldn’t raise interest rates without damaging the broader economy. So he looked for other ways to dampen the market. He put strict limits on the amount of mortgage insurance the Canada Mortgage and Housing Corp. can issue. He cut the maximum amortization period for insured homes from 30 to 25 years. And now, according to media reports, the Office of the Superintendant of Financial Institutions is considering tightening the rules for uninsured mortgages as well.

Taken together, these initiatives have taken some of the air out of a potential bubble before it pops. Earlier this year, Flaherty told a Senate committee hearing that he didn’t think Canada has a housing bubble, but “if we had failed to take some action, we would have had a bubble.”

I’ve been told many times that the media is somehow trying to cause a housing crash by predicting it will happen. But the truth is exactly the opposite: raising awareness of a threat helps to prevent it. So yes, there will be a drop in housing prices, but it might not be as bad as it could have been. You’re welcome.

Duncan Hood is Editor of Canadian Business magazine.

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