By Tom Bradley

Having been early and loud with my concerns about Canadian housing prices, I’m following with interest the daily coverage of the residential real estate market. I have a few thoughts on what I’ve read so far.

Not a big deal … yet

Despite all the front page coverage, the weakness in the market hasn’t amounted to much yet. A few markets, or pockets, are down meaningfully, but the overall price declines can’t be described as anything worse than a ‘flat’ market. I expect it will get a lot weaker, but the declines so far are no worse than some of the lulls we’ve had during this long run.

More interesting to me is the lower sales volumes. When houses aren’t moving, it’s often a precursor to lower prices. But again, we shouldn’t read too much into the current slowdown. Recent volumes are being compared to some pretty rarified levels. I’m sure my real estate agent friends won’t agree, but today’s turnover isn’t that bad. There are still houses selling in less than a week.

Blame Flaherty

In every article about the softening market, the changes to the mortgage insurance rules by CMHC are mentioned in the first five or six paragraphs. Finance Minister Flaherty is always being blamed for the slowdown. Well, certainly the changes have prevented some transactions from getting done, but let’s not forget, a mortgage with a 25-year amortization and 2-3% interest rate is a pretty sweet deal. I think the real estate industry needs to give its head a shake. Does our housing market really need 35-40 year mortgages and near-zero rates to stay healthy?

There are a few other reasons why the market might be slowing down. Even if CMHC reversed the rules tomorrow, we’d still be in a situation where:

  • House prices have grown much faster than incomes for more than a decade.
  • The buy vs. rent ratio is out of whack (in favour of renting).
  • Consumer debt levels are at all-time highs.
  • And the housing affordability index is on the expensive side, even though near-zero rates are being used in the calculation.

The only thing we should blame Mr. Flaherty for is not doing something sooner. Former Bank of Canada governor David Dodge had it right when he went ballistic in 2006. When CMHC increased the allowable amortization period to 35 years and permitted interest-only mortgages, he said, "Particularly disturbing to me is the rationale you [CMHC] gave that 'these innovative solutions will allow more Canadians to buy homes and to do so sooner.'" Mr. Dodge said that these new practices were more likely to drive up prices and make houses less affordable.

Recovery from what?

I think it’s telling that although we really haven’t had any meaningful weakness yet, there are already some industry people calling for a recovery. It’s telling because it reveals how programmed we are for steadily rising prices. To call for a turnaround when prices only started weakening a few months ago is absurd. As of December 31st, Toronto condo prices are up 7% year over year, not down.

An overvaluation in the housing market can play out in any number of ways. Higher unemployment and rising mortgage rates would likely mean a significant, early 90’s type fall. An okay economy and continued low rates might allow prices to stay near current levels for a number of years. And there are all kinds of other possible scenarios.

The ‘prices leveling off’ scenario is the consensus right now. In the paper yesterday there were two bank CEO’s and the head of a real estate company predicting “relatively stable” price levels, a “soft landing” and “flat sales volumes” year over year. As I’ve said before, long-running, extreme economic cycles very rarely end without a severe reversal. In fact, I can’t think of any. Of all the possible scenarios, I think it’s heroic to predict that house prices are going to flatten out after they’ve been rocketing up for more than a decade.

What I said in a June, 2006 blog posting about the U.S. housing market seems apropos for Canada in 2012: “I thought the U.S. housing boom would have ended a couple of years ago. I've been wrong on that. But by going on longer and climbing to greater heights than many of us expected, it has made a long and ugly retrenchment all the more likely.”

My views may prove to be early or just flat out wrong, but the point here is that we shouldn’t be too hasty in drawing any conclusions, especially based on short-term stats and self interested predictions. We’re in the early innings of a fascinating game.