Canada shows signs of housing bubble: report

Canada's housing market is beginning to show signs of being in a bubble, leading Edward Jones to caution Canadians about investing in housing and suggesting they prepare for the impact of a downturn on the broader economy.

Canada exhibits at least two of three characteristics common to asset bubbles, say the report's authors, market strategist Kate Warne and financial services analyst Craig Fehr, primary among them prices that have risen too fast and credit that is easy to obtain.

"Canada's housing market escaped the recent severe downturns in the U.S. and other countries. However, today's conditions in Canada share some characteristics of those countries prior to their downturns, leading us to take a cautious stance on housing investments," the financial services firm said in its report.

"Our main concern is that prices have risen faster than economic fundamentals warrant and could decline, although we don't expect a 'housing bust'."

A regulatory regime that has had some of its excesses pruned out will help prevent that from happening, and keeps the country from qualifying for the third condition necessary for a bubble — lax regulations.

However, average home prices have soared 19.3 per cent in 2009 to $337,410 and now stand at five times the average after-tax income, instead of the long-term 3.7 times.

By some estimates, this makes Canadian homes overvalued by anywhere from 10 to 15 per cent, the report said. Edward Jones did not offer an estimate on how much prices could decline.

At the same time, consumer debt has correspondingly risen to record levels — 142.6 per cent of disposable income at the end of 2009, with mortgages accounting for 93 per cent of that.

All of which spells trouble for the economy, says Edward Jones.

As rates rise, consumer spending will fall. Today's larger number of variable-rate mortgage holders will find bigger portions of their already limited disposable income going toward home costs. Overall economic growth will suffer as a result.

Meanwhile, mortgage delinquencies will rise along with rates, as they have begun to do recently. On Tuesday, CIBC, Desjardins and Scotiabank all followed higher rates set Monday by Royal Bank and TD Bank.

If delinquencies were to rise from the current 0.5 per cent to two per cent, and those delinquencies were to default, they could add 47,000 homes, or 30 per cent of 2009 housing starts — to the housing supply.

Warne said the possibility of a housing downturn suggests equity investors should keep no more than 16 per cent of their portfolios in financial service stocks.

(prepared by John Morrissy/Financial Post/Vancouver Sun)