Chill sets in as prices, rate worries hit housing market

The remarkable recovery in Canada’s resale housing market is cooling, as increasingly expensive properties and the promise of higher mortgage rates force out buyers.

Prices are at all-time highs, but the number of homeowners looking to sell has created a glut of inventory. At the same time, anticipated higher mortgage rates and stricter qualification rules threaten to price more people out of the market, ultimately driving prices lower as fewer buyers compete for what’s available.

Any slowdown would hurt the economy. The housing market has been key to Canada’s recovery, with average prices up 23 per cent from their lows at the end of April, 7 per cent higher than they were going into the recession. The average price of a home at the end of April was $344, 968, the highest on record.

Lower prices and higher mortgage rates mean homeowners would pay more money to service their mortgages, while others could be forced to sell. Rates have recently dipped and are near historic lows, but are expected to rise again.

CIBC World Markets economist Benjamin Tal said prices could fall by as much as 10 per cent in the next two years, but that a "violent" correction similar to the one seen in the U.S. remains unlikely.

"We are more likely to see higher interest rates causing a modest decline in prices," he said. "Because we lack the driver for a more violent decline, we should expect a more orderly rebalancing."

The recovery has overshot what is justified by the economy, he said, with 17 per cent of Canadian homes trading above their fair value, according to his analysis. Modifying a formula created by the International Monetary Fund, he said prices are higher than they should be in Canada, "as justified by housing market fundamentals such as income, rent or demographic changes."

His research indicated that 20 per cent of homes are considered overvalued in British Columbia, 17 per cent in Alberta, 13 per cent in Manitoba and Saskatchewan, 13 per cent in Quebec, 11 per cent in Ontario and 8.6 per cent in Atlantic Canada.

Royal Bank of Canada said the cost of ownership rose for the third straight quarter across all housing segments in the first quarter. Economist Benoit Hogue said even if prices decline, higher mortgage rates will ensure Canadians spend more on housing for at least the next two years.

According to the bank’s criteria, housing costs are now "moderately" above their long-term averages, but below the peak hit in early 2008.

"Put it this way, it is getting harder and harder to afford a house," he said. "Home ownership costs are starting to bite typical Canadian households but not dangerously so."

Last week, TD Bank issued a report that suggested prices could fall by 2.7 per cent in 2011. The Canadian Real Estate Association expects to see a decline of 1.5 per cent. Among recent forecasts, only the Canada Mortgage and Housing Corp. calls for higher prices in 2011, with an anticipated gain of 1.3 per cent.

Almost 100,000 homes were listed for sale in April, according to the CREA, while month-over-month sales declined by 2.6 per cent. It’s the third time in four months that the number of sales has decreased.

In markets such as Toronto and Vancouver , the tone of the market has changed as buyers take more time to make decisions and houses sit longer on the market.

"We’re still seeing some multiple offers, but I’m definitely telling people not to list low in hopes of sparking a bidding war because you just don’t know what’ll happen," said Darryl Mitchell, managing director of Toronto’s ReMax Professionals Inc.

(prepared by Steve Ladurantaye/Globe & Mail)