Canada home prices expected to drop as costs rise

Canadian home ownership costs are rising and affordability is eroding, while overvalued house prices are due for a correction in the coming year or two, a pair of reports by banks said on Tuesday.

CIBC World Markets’ new Home Ownership Affordability Index found home ownership was within reach for most Canadians but increasingly difficult for some. It also said about 17% of all dwellings in the country were above fair value.

"While the booming housing market is starting to come back to earth, the fact that prices are overvalued today does not necessarily mean that they will crash tomorrow," said Benjamin Tal, senior economist at Canadian Imperial Bank of Commerce. He predicted that higher interest rates will lead to a modest decline in prices, probably between 5% and 10%, in the coming year or two.

The CIBC index considers demographics and mortgage type, in additional to the price of homes, interest rates and income. "The vast majority of home owners in Canada, regardless of their age have not experienced any worsening in affordability despite the rapid increase in prices," said Mr. Tal, noting that the average size of a mortgage, which has risen 42% in six years to $170,000, has not coincided with a significant worsening in affordability.

But CIBC found that families with household incomes of less than $50,000 were spending close to 60% of gross income on mortgage payments, property taxes and electricity costs. "This is three times the average ratio seen among households at the same age groups but with income of over $50,000," said Mr. Tal.

Separately, the RBC Housing Affordability measure for the first quarter of 2010 showed that home ownership costs had risen across all housing segments, according to a report by Royal Bank of Canada.

The RBC report found that measures rose at the national level by 0.9 percentage points for a detached bungalow, 0.4 percentage points for a standard townhouse, and 0.5 percentage points for a standard condominium. The standard two-storey home increased by 0.6 percentage points.

The RBC index measures the proportion of pretax household income needed to service the cost of owning a home. The higher the measure, the costlier it is to afford a home.

Rising interest rates will likely be a main factor affecting affordability. Market observers expect the Bank of Canada will soon raise rates, as soon as next week on June 1, as the economy has shown considerable strength.

"We believe that the spectacular rally in housing prices over the past year will soon end, as rock-bottom mortgage rates increase," said Robert Hogue, senior economist at RBC. "Sustained economic growth over the next year and the ensuing rise in job creation and household income should keep home affordability from spiraling out of control," he added.

Posted mortgage rates started to perk up about a month ago, but have since been pared back after government bond yields fell during the European debt crisis.

CIBC trimmed its five-year rate on closed mortgages to 5.99% on Friday, down 0.11%.

While affordability is expected to deteriorate throughout 2010 and 2011, Mr. Hogue said cost increases should be "limited as more balanced supply and demand conditions will take much of the steam out of the housing market."

CIBC’s Mr. Tal said "stabilizing forces are already at play", pointing to rising new listings and a slower pace of climbing home prices.

Home resales slowed in April while new listings climbed, suggesting the country’s real estate market could soon start to cool after a year of surging prices.

(Source: Reuters/Vancouver Province)