Strategy

Outlook 2007: Real estate

Six of Canada's foremost economists forecast the coming year

Video

Six of Canada's foremost economists forecast the coming year

Outlook 2007:ÂÂ The global picture Â|Â Canada, by province Â|Â Oil Â|Â Real estateÂ|Â Productivity Â|Â Canada and Asia
Interviews
Video:
ÂÂ Roger Martin Â|Â John Shackleton Â|Â Bill Morris

Previous projections:ÂÂ Outlook 2006 Â|Â Outlook 2005 Â|Â Outlook 2004

Canada's housing market topped even the most optimistic expectations in 2006. Sales and new construction essentially mimicked 2005's strong performance. National home prices notched up another 11% gain, and renovation spending broke new records. Much of the buying frenzy happened in the booming western provinces, where price increases reached historic proportions. Most markets east of the Manitoba border, while still quite buoyant, have cooled somewhat.

Regardless of geographical location, the new year will likely mark the beginning of a more synchronized housing-market slowdown across the country. The simple reason is that houses have become much less affordable for first-time homebuyers. The average price of a resale home in Canada has soared more than 60% during the past five years, reaching nearly $300,000. Adjusted for inflation, this has been one of the strongest and longest bull runs in Canadian residential housing history.

For many current renters, or for potential investors intending to lease properties, home ownership is not as viable as it was just a few years ago. Consider this: the average monthly rent on a two-bedroom apartment in Canada is roughly $750, whereas the typical monthly mortgage payment on an average-priced home is about $1,550. That puts the average buy-over-rent monthly premium about $800–the biggest affordability gap since 1990, and far above a low of just $250 in 1998.

Potential homeowners do have more financing options than ever before. They may be able to reduce their monthly debt payments through interest-only mortgages, no-down-payment mortgages and amortization periods of up to 40 years. And they might consider condominiums, townhouses and semi-detached homes, which generally offer a more affordable entry point compared with the “average-priced” home. Others may accept a much longer commute to make the dream of homeownership a reality. Nonetheless, reduced affordability and limited pent-up demand suggest that first-time buyers will make a smaller contribution to overall housing demand than they did during the first half of the decade.

On the other hand, existing homeowners who have already built up equity in their homes may remain active “move-up” buyers in 2007, as the pool of listings grows and price increases moderate. Moreover, even as sales and construction slow, a record number of home sales in 2005-06 will sustain the boom in renovation activity for some time. Most renovations are undertaken in the first three years following a resale home's purchase. For many families, high home prices mean upgrading is an increasingly attractive alternative to moving.

The risk of a major housing correction remains relatively small. Undeniably, a more pronounced economic downturn in the U.S. would spill over into Canada through reduced export and hiring momentum. But by and large, the annual double-digit rises in home prices in Canada in recent years were driven by a combination of strong demand and tight supply. We've seen little evidence of the speculative buying that emerged at the tail end of the 1980s housing boom. Compared with the U.S., there is also much less indication of overbuilding in Canada. Importantly, faced with the prospect of slower North American growth, interest rates are expected to remain low, and possibly move lower, over the coming year.

While there's little reason to fear a crash, today's more balanced market conditions point to more modest price gains in 2007. High home prices are drawing out more listings, leading to fewer bidding wars and longer times on market. That, combined with softening demand, should drive the national average price increase in the middle single digits in 2007. Big regional differences will likely persist. Price trends and construction activity will remain firmer in the West, supported by the region's strong labour markets, tighter supply-demand conditions and the tide of Canadians migrating there from other parts of the country.

Adrienne Warren is a senior economist and manager at Scotiabank in Toronto