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Housing Bubble Watch


As a result, the national average price of exist­ing homes continues to climb at a vigorous pace, rising in the first quarter at an estimated 10% year-over-year - not much different from the national average experienced over the past few years and well above any assessment of a sustainable rate. However, like so many other recent eco­nomic indicators, these national figures significantly mask a great divide emerging from a regional perspective.

East of Manitoba, house prices are now experiencing softer growth than the national average, with the annual rate of appreciation in several markets cooling to the mid-single digits. But it's important to note that this is not a reflection of any substantial drop in sales activity.

Indeed with affordability still attractive from a historical perspective, existing home purchases remain near record level in a number of markets. Instead, potential buyers have been given more choice, as an increasing supply of prod­uct (both from the new and resale housing market) is help­ing to alleviate the strong price pressures that hung over the market in the past. This "soft-landing" in price growth" provides some evidence that these markets did not previ­ously experience a speculative bubble that required a cor­rection - an argument we have been making for more than a year.

Meanwhile, housing conditions in Western Canada re­main very tight. Activity has become so intense that home price growth has accelerated to over 20% in year-over-year terms in some markets. Much of this outsized growth can be attributed to surging commodity prices, which have lit a fire under the economies of the resource-based West raising housing demand relative to available supply. Thus strong economic fundamentals, together with capacity strains on the supply side, largely explain the lofty price growth in most Western markets.

However, when economic conditions are booming, it can also create the perfect breed­ing ground for speculative price bubbles to form. That's because in such an environment, housing market partici­pants are at greater risk of developing a case of "irrational exuberance,'' especially if they expect that such exorbi­tant price gains will continue indefinitely.

There is no denying that British Columbia is currently enjoying one of the strongest economic booms in its re­cent history. Unemployment rates have sunk to all-time lows, while the province is poised to once again sit at the top end of the provincial economic growth tables in 2006. Vancouver is unquestionably benefiting from this provin­cial economic renaissance, with the city receiving a big economic jolt from a number of infrastructure investments now occurring, some of which are related to the 2010 Winter Olympics.

Consequently, it is not too surprising that Vancouver's housing market remains on fire. This city currently leads the country in terms of price growth, up a whopping 22% year-over-year in the first quarter of this year and with the average home price fetching an all-time high of close to a half a million dollars - also the highest in the country But in addressing the matter of a speculative housing bubble, the more important question to answer is: are these robust economic fundamentals in Vancouver strong enough to support such price gains?

Based on a number of indicators, we still don't think so. For example, while Vancouver's housing market remains quite tight, the inflation-adjusted prices are actually growing faster than what underlying supply and demand conditions would warrant. And despite today's historically low mortgage rates, affordability continues to deteriorate in Vancouver For example, five-year mortgage rates averaged a still lower 6.38% in the first quarter of this year, yet it took a whop ping 42.1% of median pre-tax household income to own an average home in this city. That compares to "only1 39.8% in ! 995 when five year mortgage rates were close to 9.00%.

This is not a rational outturn, since lower mort gage rates should help to keep the housing market afford able (just as it has done in most other regions of the country) — not worsen it.

And while Vancouver's labour market is indeed very strong, the steady deterioration of affordability in the city also suggests that income growth has not been robust enough to provide a sufficient offset to the rapid ascent o home prices - as an aside this is in sharp contrast to cities like Calgary where home prices are also accelerating, yet extremely robust income growth has helped to keep that city's affordability rates relatively stable.

So how are potential buyers able to afford homes in Vancouver? The provincial personal savings rate provides a clue, as it sank to an all time low of-7.9% in 2004 and likely retreated further since then. That's also the worst rate in the country and suggests that, on average, potential homebuyers in Vancouver may be forced to carry a far greater debt load than other Canadians simply to own hous­ing.

Why potential homebuyers would choose to do so when it is considerably cheaper to rent a comparable prop­erty is hard to reconcile, but many may be doing so with the belief that if they did not "they would be priced out of the market forever." Such a fear is an inherent feature of all speculative bubbles.

Still, some observers have defended Vancouver's cur­rent outsized price gains on the basis of the recent pick-up in population growth. Population growth is no doubt a long-term driver of housing demand, but it's worth noting that the recent pick-up in Vancouver has been much weaker than in other periods when the economy was booming. In fact, interprovincial migration (a key driver of new hous­ing demand) turned slightly negative in the last quarter of 2005 and remains well below levels seen in previous cy­cles.

Although we think housing market in Vancouver has shown signs of a bubble, it's important to note that any softening in these markets is not likely to be triggered by a deterioration of economic fundamentals. In­deed, we expect strong economic growth in the province to continue over the next few years. For a comprehensive overview of the outlook for the B.C. economy please see the TD Economics Special Report: British Columbia's Golden Decade: Can this Period of Prosperity Take on a Longer Life?, March 29, 2006.

Instead, a significant change in the price environment would likely require a reversal in the overly exuberant at­titude of buyers on Canada's West Coast. While forecast­ing such changes in psychology is extraordinarily difficult, one key trend could provide a catalyst. There are already signs that overheated U.S. housing markets are cooling. Mortgage refinancing, housing starts and exist­ing home sales are all down significantly from their peaks Moreover, inventories of home for sales have been rising which is a usual precursor to weaker housing prices. In the U.S. housing markets continue to weaken, as we expect they will, this could act to temper the speculative activity in B.C. real estate markets, as the U.S. media coverage will remind buyers that prices don’t just go up.

For more information please contact: Mina Mohtadi, MBA Manager, Residential Mortgages,

Tel: 604-809-3033