Housing bubble risks exaggerated: TD economist

(April 27, 2005) The housing market is on its way to experiencing one of the longest cyclical booms in recent history and the high levels of activity are prompting many to believe the sector is inflated and house prices are on the verge of collapse.

Not true, say economists at the TD Bank Financial Group. One of the key tenets of a housing bubble, namely speculative buying, is simply not present in the market except in a few isolated places. Furthermore, they say underlying forces of supply and demand are behind the run up in prices and current economic conditions will likely support house prices going forward. Currently, annualized real price gains are sitting around 7%.

One caveat: property developers must remain cognizant of demographic trends to keep home prices supported and the housing market broadly in balance between demand and supply.

In a topic paper released today entitled Bursting aspects of the housing bubble myth, TD economists address several specific fears about the housing market that the authors say are largely exaggerated.

“Canada’s red-hot housing market is on a solid foundation,” says economist Carl Gomez. “There is very little evidence of speculative activity. While a modest cooling is in the cards this year and next, there are a number of misconceptions about the state of this housing market and where it is going.”

The first concern is homeowners will be hurt once interest rates start to rise. Economists say this assumes most homebuyers are taking out floating variable rate mortgages that expose them to risk. Although these mortgages are becoming more popular, fixed rate mortgages continue to be the most frequently used financing option for more than half of all homeowners in Canada. Five-year fixed rate terms are presently the most popular option. As well, the paper argues that the risk of an interest rate shock in Canada is quite low given the current benign inflation environment. Core consumer prices “continue to sit just below the midpoint of the Bank of Canada’s inflation target and inflation expectations remain well contained,” say the authors.

The condo building boom in urban centres, particularly in Toronto and Vancouver, is also adding fuel to bubble concerns. The report says it is true that most potential homebuyers would prefer ground-oriented dwellings like single family homes but condo living is becoming more appealing, thanks to the growing number of small households and the allure of living with numerous amenities. Also, the efficient use of land helps to keep housing costs affordable for those who want to remain close to urban centres.

Furthermore, the report points out that the property development industry has adopted risk management practices like pre-sale requirements, which have resulted in a more manageable number of unoccupied condos coming to market.

Finally, many assume that home prices will ultimately collapse sometime in the next decade as baby boomers retire and start selling their homes. The reality of the situation is “most retiring boomers are likely to stay put in their current homes for many more years to come,” and there are just as many younger boomers with growing families who will continue to be active players in the housing market.

This fact seems supported by a small survey conducted by Ipsos-Reid and RBC Financial Group that found nearly half of Canadians who plan to buy a home in the next two years intend to buy one that is bigger than the home they currently reside in.

The TD report goes on to say that senior boomers will continue to see some of the fastest growth in wealth and disposable income than any other age group. “The 65 to 74-year-old category should easily become the peak age group for home ownership in the next few years.”

Gomez concludes the study saying home ownership remains a sound investment assuming the market remains fairly balanced and the economy grows moderately. He says TD expects home prices to grow at an average annual rate of about 3% over the next decade. The after-tax return is closer to 6% considering the fact that there are no capital gain taxes on the sale of a principle residence.

“The return per unit risk in housing has actually been better than in the topsy-turvy world of stock markets,” says Gomez. “That’s reassuring given that land and structures account for more than one third of households’ total assets.”

Filed by Kate McCaffery Advisor.ca, kate.mccaffery@advisor.rogers.com