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We’ve already looked at the surprising strength in the Canadian real estate market which is causing many analysts to question if it is approaching extremes at which the dreaded ‘bubble’ moniker applies.
The latest report is from David Rosenberg and while it doesn’t outright label it as such, he manages to imply it as strongly as possible. Here are a few charts he features to support his argument:
In answer to the question as to whether prices are in a bubble, all we will say is that when we ran some charts showing Canadian home prices normalized by personal income or by residential rent, what we found is that housing values are anywhere between 15% and 35% above levels we would label as being consistent with the fundamentals. If being 15% to 35% overvalued isn’t a bubble, then it’s the next closest thing. We are talking about 2-3 standard deviation events here in terms of the parabolic move in Canadian home prices from their lows. So, if it walks like a duck …
The bold is my own emphasis by the way. Rosenberg goes on to say that rates can only go up (which will weaken or break prices). While this is correct, he is also among those who insist that the Bank of Canada will hold rates steady for a long time. They’ve already said they will wait until the first quarter of 2010 before tightening and there is good reason to believe it will be later. Even when rates do start rising, it will be very gradual to coddle the nascent recovery.
While the data certainly looks ominous, I think the Canadian real estate market will keep chugging along. To see why, let’s take a look at the demand and supply.
On the demand side you have the government support measures: 5% down-payments, 35 year amortizations and behind the scenes, the Insured Mortgage Purchase Program (IMPP) and the Canadian Lenders Assurance Facility (CLAF). As well, thanks to historic low interest rates and relatively stable incomes, home affordability has continued to improve.
Don’t forget, rising rates mean an improving economy. So although it will become a bit more expensive to buy a house, improved incomes will keep affordability relatively stable. Therefore, one can argue that demand is going to continue strong in almost any scenario (other than an utter economic collapse).
Finally, public sentiment isn’t signaling a top. You don’t have people ‘flipping houses’ or convinced of riches from simple real estate transactions. Instead, people just want to buy a house to live in instead of renting. The only anecdotal sign of froth is people lining up at condo sales in Toronto. But perhaps that’s merely a reflection of the lack of supply.
Looking at the supply side, Rosenberg mentions that inventory is tight:
…sales-to-new listings and inventory-sales ratios are about the tightest
they have been in the past two decades…
… we are 40% below the overbuilt levels that touched off the home
price slide back in early 1990s…
So the real question that will determine real estate prices is how fast builders will react and bring on significant inventory. Due to the nature of real estate, that simply can’t happen overnight. The process for new developments takes considerable time. I would guess, even if builders reacted immediately and had access to credit (something that Rosenberg himself has mentioned they don’t due to banks not lending) it would take them at least 14-18 months.
So while it looks ‘extreme’ on these charts, it will continue to get even more extreme. As well, the Canadian REIT sector continues to be fully priced but not a ‘bubble’.
You can read the complete report from the FREE trading resource section (Reports & Articles folder). You’ll also find two other reports that say basically the same thing - from Scotiabank & RBC.
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