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13 Mar

Lost decade predicted for Canadian housing market

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Posted by: Kimberly and Cindy Walker

Lost decade predicted for Canadian housing market 7

Home prices boom is now a bust; future increases will mirror rate of infl ation

Think of it like an elastic ( being stretched). The snap back is going to be a lot harder.
GRANT CONNOR
NATIONAL BANK FINANCIAL

After years of growth, economists say the real estate boom is over and predict Canadian housing prices to flatline over the next decade.

                        IAN LINDSAY/ PNG FILESEconomists say the party is over for large returns on real estate investment in Canada. While residential home prices increased by an average of 5.4 per cent a year between 1980 and 2012, they see annual returns of between two and 3.5 per cent over the next few years.

TD Economics study, LongRun Rate of Return for Canadian Home Prices, predicts a “string of lacklustre performances” over the next few years. The annual rate of return for real estate will be about two per cent over the next decade, meaning that prices will simply match the pace of inflation.

Meanwhile, another report warns that a severe economic shock, such as the kind that hit Japan in the early 1990s and California and Nevada in 2006, could knock Canadian housing prices down by 44 per cent. While not predicting the extent or cause of a large- scale house price depreciation in Canada, Moody’s Investors Service included the figure in a report on its proposed approach to analyzing the credit risk of noninsured mortgage pools.

“There is some overvaluation in the housing market — home prices have moved away from their underlying economic fundamentals — and that overvaluation has to unwind,” said Sonya Gulati, senior economist at TD.

This adjustment, however, will be gradual, she added. “With the U. S., it was a housing market bubble and all of a sudden, a pin came and pricked it. It completely burst. The way you want to think about the Canadian housing market is that there’s a balloon that’s been inflated but instead of a pin coming and pricking the balloon, the air is going to be slowly let out.”

Canadian residential home prices grew by an average of 5.4 per cent a year between 1980 and 2012, climbing about seven per cent per year in the last decade.

The market has cooled over the last six months and will continue its slide over the next few years as tighter mortgage rules, modest economic growth and higher interest rates push prices downward. The economists project a 3.5 per cent annual rate of return on real estate beyond 2015, a low rate that has not been seen since 1980.

However, Moody’s Investors Service analyzed housing prices in the event of a pin coming along. A 44 per cent decline would be driven primarily by the phenomenal upswing in Canadian home prices over the past decade, Moody’s said.

While house prices in Spain could plummet by a more severe 52 per cent, Canada joins Spain, as well as the United Kingdom and Australia, in the ratings agency’s assessment of countries where growth in housing prices over the past 10 years has driven their values away from sustainable market fundamentals and into “overheated” territory.

“As with Australia, Spain and the U. K., we expect house prices in Canada to suffer the most due to the misalignment of current house prices with historic fundamentals,” Moody’s said.

The ratings agency released the report Monday that included its housing market analysis, along with request for comment on its proposed approach to analyzing the credit risk of non- insured mortgage pools.

“Moody’s Investors Service is in no way predicting the extent nor the causes of a large- scale house price depreciation in Canada,” spokesman Thomas Lemmon said in an emailed statement.

Moody’s is the second ratings agency in as many weeks to seek input on a proposal to change the methodology used to analyze securities linked to mortgages.

Last week, London and New York- based Fitch Ratings unveiled a proposed a two- step model that reduces home prices to a “sustainable” value based on a number of factors including data provided by Canadian banks. It then further subjects the homes to a “stressed market” value decline assumption.

Fitch said Canadian home prices are overvalued by about 20 per cent.

Ratings agencies came under harsh criticism in the aftermath of the financial crisis of 2008 for what was perceived as a failure to predict the U. S. housing market meltdown that precipitated it.

Since then, there has been an attempt to strike a balance of thorough analysis with timely analysis, according to Grant Connor, an associate in equity research at National Bank Financial who previously worked on structured finance at Moody’s.

The model proposed by Moody’s on Monday determines house price “stress” rates by looking at variable factors such as house price and income growth over 10 years, and fixed factors such as monetary policy.

The analysis of housing prices in the event of economic shocks includes data from Finland in 1989, Japan in 1991, and Hong Kong in 1997, as well as Ireland, Nevada, and California in 2006.

The “variable” analysis assesses how much current house prices have departed from “sustainable” market fundamentals. The assumption is that, in the event of a severe economic shock, expected demand that has been baked into current house prices will not materialize.

“Think of it like an elastic ( being stretched),” explains Connor of National Bank Financial. “The snap back is going to be a lot harder.”

Moody’s assesses the “fixed” factor, which rates how vulnerable the consumer is to economic shocks, whether there is a large oversupply of houses, how effectively monetary policy can alleviate the shock, and how dependent the economy is on the real estate sector.

Canada scores better in this area, says Connor, because the stability of the country and its monetary policy is taken into consideration.

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