Canada’s much-talked about real estate market is set to underperform other types of investments unless incomes rise or price increases taper off, according to a new report by CIBC. But Benjamin Tal, the report’s author, says a major crash in the real estate market is unlikely.
“Glancing at popular metrics such as the price-to-income ratio or the price-to-rent ratio, it is tempting to conclude that the housing market is already in clear bubble territory and a huge crash is inevitable,” Tal says.
“Tempting, but probably wrong.”
VANCOUVER AND TORONTO SKEWING THE DATA
The price of the average home rose by 8.6 percent in May on a year-over-year basis.
But if Vancouver’s explosive housing market is excluded, Tal says the year-over-year increase in Canadian home prices falls to 5.6 percent. If Toronto is also excluded, the number falls further to just 3.7 percent.
For a crash to happen, Tal says two conditions must be met:
1) A drastic rise in interest rates, similar to what happened in 1991
2) A high-risk mortgage market sensitive to any economic changes.
Tal believes a sudden cycle of rate hikes by the Bank of Canada is “unlikely.”
“Digging deeper and looking at the households with both low equity positions and high debt-service ratios, we found that this fragile segment of the market accounts for only 3.2 percent of total mortgages,” he writes. “Shock the system with a 300-basis-point rate hike and that number would rise to a still-tempered 4.5 percent.”
Tal believes the most likely scenario is a gradual national correction as interest rates move higher.
“That could still entail a period in which housing underperforms other assets as an investment class, until rising incomes and a tame price trajectory brings the market back to equilibrium,” he writes.