As the housing market stalls, several people who bought pricey Vancouver condos before they were built are suing to get out of the deals. In Toronto, condo sales during the first half of the year fell for the first time since 1994. And at least one homeowner near Halifax just offered to give away his house for free, so long as whomever took it assumed the $395,000 mortgage. Everywhere, tales of real estate woe and miserable sales data have prompted predictions of a crash. James Grant, a prominent U.S. investment newsletter author well known for his bearish outlook on the American economy, has warned house prices here are primed to fall: “The median Canadian house is, in fact, certifiably unaffordable.” Even if prices tumble, though, as happened in 2008—when the economy was also teetering and house prices were at record levels—they could still make another surprising comeback.
No question Canadian prices are outrageously high. As Grant points out, compared to rental rates, home prices in Canada are more than 60 per cent above the historical average. And with home ownership rates and household debt levels higher than they’ve ever been, Scotiabank economist Derek Holt says there’s nowhere for prices to go but down. “This time when we come off the boil, prices are going to stay lower,” he says.
That’s quickly becoming the prevalent view. And another modest eight to 10 per cent correction could occur. But if that happens, there are reasons to expect a repeat rebound, as happened previously when the Teranet-National Bank house price index slipped eight per cent in 2008 and then roared back 18 per cent, reaching an all-time high two months ago. That’s because mortgages remain wildly cheap and, if anything, are getting cheaper. True, the Bank of Canada has raised interest rates twice since June to 0.75 per cent. That only affects homebuyers taking out variable-rate mortgages, though, which currently sit at 2.75 per cent. The fact is, lenders are furiously cutting fixed-rate mortgages. Since May, five-year fixed mortgage rates have fallen to 3.99 per cent from 4.75 per cent, according to Canequity.com.
Another reason house prices rebounded so sharply after the 2008 drop was that there were far more buyers than sellers. As the financial crisis hit in 2008, new home construction slowed while sellers yanked properties off the market, lest they get caught in a downward price spiral. But when the Second Great Depression in Canada turned out to be Just Another Recession, home buyers flocked back to the market before sellers had a chance to react, thus driving up prices. A similar phenomenon could play out again.
But if another rebound occurs, it will likely be triggered by Ottawa. The Harper government has repeatedly intervened to micro-manage the $2.8-trillion housing market. Before the U.S. subprime mortgage crisis hit, Ottawa dramatically loosened mortgage rules, allowing Canada Mortgage and Housing Corporation to insure zero-down, 40-year mortgages. Ottawa reversed course when such loans were shown to be dangerous. But with the recession, Ottawa swung back into action. It offered first-time home-buyer subsidies, allowed Canadians to withdraw more from RRSPs to buy homes, and authorized CMHC to take $75 billion of mortgages off lenders’ hands. Finally, as the market began to overheat in February, Finance Minister Jim Flaherty tightened mortgage lending standards. But Holt says Ottawa may loosen mortgage restrictions once again if the housing market craters. And it seems entirely possible the government will use its clout through CMHC to spur banks to lend and people to buy.
Efforts to halt prices from falling sharply might keep homeowners, and hence millions of voters, happy, but it’s bad economic policy. First-time buyers would be forced to take on even more dangerously large mortgages. At the same time, if the housing market continues to swing up and down, that eventually translates into stagnation—albeit at high levels.
Which is why many believe it’s time to let the housing market pursue its own trajectory—and, given recent data, that would appear to be down. “There’s a strong case to be made for letting the markets follow their natural evolution, and the U.S. offers a good lesson,” says Holt. “Every time they’ve tried to use stimulus to avoid what’s inevitable in the long run, they end up making things worse.”