The call is coming from inside the House. Canadian real estate is significantly overvalued, according to the government’s own research. A new report from the non-partisan Parliamentary Budget Officer (PBO) dropped this week. It looks at housing affordability, and is meant to give policymakers a primer on the issue. The report concludes real estate prices grew far more than income and credit. By their calculations, some markets are now over 50% overvalued with many more just under that. The agency warns this will make households vulnerable to economic shock.
Canadian Real Estate Markets Are Up To 50% Overvalued
The PBO’s report on housing affordability shows home prices are significantly overvalued. They found Toronto, Hamilton, Halifax, and Ottawa were over 50% overvalued in December. Home prices have advanced tens of thousands of dollars since then as well
Canadian Real Estate Overvaluation
The estimated overvaluation of a composite benchmark home based on the attainable price credit should allow. Positive numbers indicate an overvaluation, while negative numbers show under undervalued markets.
Source: PBO; IMF; Better Dwelling.
Even more Canadian cities were significantly overvalued, just not as much as Toronto. Prices in Vancouver, Montreal, and Victoria were between 30% and 45% overvalued as well. These are massive overvaluation numbers that only look small compared to Canada’s world-class bubbles.
Canadian Home Prices Rise Above Credit After 2015
Canadian residential real estate prices began to outgrow credit over six years ago. The PBO calculations show credit and income no longer explain prices after 2015. “In early 2015, house prices in most CMAs were below, or close to, affordable levels based on normal utilization of its borrowing capacity,” writes the PBO.
After 2015, Canadian real estate prices began to really take off. It consistently outpaces credit growth, and then accelerated when the pandemic hit. Low rates are often the fuse that kicks off a buyer exuberance spree. Other factors also contribute to this kind of behavior, such as seeing large profits.
The Bank of Canada (BoC) recently called out the market’s exuberance. They said buyers are now paying higher prices, because they expect them to always grow. It’s a classic hallmark of a real estate bubble to explain growth based solely on expectation.
Speaking of real estate bubbles, PBO findings are consistent with the Federal Reserve. The US central bank’s Exuberance Index also shows Canada’s real estate bubble began in 2015. There’s been a brief break in the trend, but it shows fairly persistent froth.
Canadian Home Buyers Are Vulnerable To Shock
High home prices are pushing Canadians to the limit. The PBO stresses household budgets are approaching their maximum at the national level. “House prices that exceed affordable levels imply that a household is stretching its finances and borrowing capacity, increasing its vulnerability to adverse economic shocks,” said the PBO.
The PBO used mortgage debt servicing capacity to determine most of the country is at its upper limit. Pricey cities like Toronto and Vancouver are way above their upper service capacity. The stress test increases durability against shock. However, the larger the regular payment the more difficult it is to absorb the cost. “While approximate in nature, our results suggest that household financial vulnerability is elevated in several CMAs for households that have recently purchased homes,” they add.
Higher interest rates are a concern for the PBO, in particular for new buyers. They warn reduced credit capacity will impact affordability even further. It’s a traditional conclusion, but at odds with recent research. BoC staff research shows home prices respond to credit capacity. The central bank concludes they moved the wrong way for housing affordability for the past 30 years. Whoops!
The PBO Uses An Odd Timeline To Agree With The Government’s Existing Affordability Solution
The PBO suggests more supply is the solution to higher home prices, but in an odd way. To determine this, they compare the number of houses and people, as though one person equals one home. They also curiously used 2021 data for prices, but only 2019 data for new home completions. It feels like an oddly intentional conclusion to reinforce the one they started with.
If the PBO used 2021 data, they would have seen what banks like BMO have been saying. A near-record amount of completions and slow population growth didn’t slow prices. The opposite happened, with prices rising even faster and growing like never before.
Further, there are so many homes under construction in Canada it’s become inflationary. Material shortages, despite record production, are experiencing a squeeze. Ditto for labor, which has seen costs rise 20% over the past two years. This is resulting in more expensive homes due to rising construction pressures.
Big Six banks are increasingly saying, breaking speculative psychology is the only solution. Once the BoC raises interest rates, they also expect more inventory to hit the market. That isn’t to say building should slow, but the impact demand has on price can’t be properly assessed without efficient market credit.
About Today’s Data
There are a few noteworthy points about the PBO report that need a bit of an explanation. The first is, they say “average price,” but they actually used the CREA composite benchmark price. A composite benchmark is a weighted average adjusted for type, size, and quality. It seems this was just a terminology error on their part, but the mistake actually created a higher quality analysis.
The size of the down payment assumed is also astronomical. They use a household average of 67% loan-to-value (LTV) at originations in their math. That implies people put 33% down, which is very ambitious for new buyers. The LTV average across the spectrum is boosted by people who can leverage an existing home.
Without the frothy valuations transferred over to the down payment, it’s a lot harder to do. Bluntly put, housing might actually be much less affordable than stated. Probably not what you think of when they do an affordability analysis.
Language is also worth diving into a little further. The PBO uses the term “above affordable levels” instead of “overvalued.” It’s an IMF model, and the IMF used the term “overvalued” when discussing it with us when it was first created. The term overvalued is an objective and non-political term, so that’s what we use.
The PBO is non-partisan but still plays politics like other government agencies. Canada measures the same data points as other countries, but often softens the language. This results in Canada having unique and industry-friendly lingo that’s inconsistent with more direct international terms.
For example, Canada doesn’t have “vacant” homes but homes “not occupied by a usual resident.” Foreign buyers are a myth, but non-resident purchasers of housing exist. Money launderers are probably now referred to as global liability reduction money managers. We stick to the international and objective terms used by the agency. Sorry, eh.
Rising interest rates always work to prick all bubbles, I’m not sure how many rate hikes it will take but it won’t take many to bring in a tsunami of sellers. Markets always go up like a staircase and down like a elevator.
Surprise surprise, the PBO concludes that home prices are overvalued but the party in power already has a a plan in action to solve it.
Completely ignoring all central bank research on the topic and then pretends the no-data theory that keeps being repeated is the solution.
Government has no credibility on demand until the central bank is at the neutral rate. Until then they’re pulling a China and using building homes strictly for GDP and they want as many as possible regardless of whether people can afford them.
Government narrative is prices won’t fall but building more will make it cheaper? Homes are going to get 30% smaller every year? Is that the genius solution they came up with?
According to a former senior minister Canadian housing is primarily for foreign investors. https://youtu.be/OZChbNQWH3s
Looks like it’s all going according to “the plan”
Even prices crashing don’t make homes affordable though, so just accept you’ll be a scrub renting from someone for the rest of your life. That’s Canada in a nutshell. And voters LOVE it.
Funny how all this started in 2015. I believe that was the year the Bollywood dancing, shoe polish wearing leader came to power. Aren’t we special?
I figure Toronto is about 300% overpriced.
So wait, Toronto is considered 78% overvalued? That seems about right, subjectively speaking, but I can’t believe it’s even possible for people to overextend themselves that much.
No idea when this will normalize but when it does, wow, that’ll be a sight to behold.
78% overvalued would need a 43% correction to wipe out the overvaluation. I don’t think that’s possible but 20-30% lower and 5-10 years of no growth is a good estimate and probability.
How many immigrants are going to keep coming if local incomes can’t support shelter and immigrants make less than locals? We’re certainly not capturing high income tax payers with significantly higher taxes and seizure of funds from people if you make the wrong donation.
How did you get 43% correction from a 78% overvaluation?
Take $100 multiply by 1.78 equals $178
Take away 43% of that number so you are left with 57% of $178 and you are back to $100 basically.
I think it would be (as an example:
$1 000 000 home 78% overvalued = $1 780 000
$780 000 is the $ amount of value
780 000÷1 780 000 = 0.438
Thus a home that should be valued at $1 000 000 is currently valued at $1 780 000 and would need to drop 43.8% ($780 000) to bring it back to the appropriate valuation.
Oh, look at that. My first comment after lurking for years and I forgot to refresh to see that this had already been answered
Felix – I want whatever you are smoking if you think in 5-10 years Canadaian RE will be price less than what it is now.
I am a plumber in BC. Real estate building cannot keep up with population growth for many reasons. We have a housing shortage, and barring a plague, demand will easily outweigh supply. No bubble here. Laws are even coming down harder on those living in vans, etc.
Costs to build will continually climb. Unlike your prediction, I predict prices keep going up and maybe laws will start shifting towards more carriage houses for those who own houses. Thus, even more demand and rising prices.
What I’m finding is the majority of people don’t understand what a bubble is. You just defined one — a squeeze on prices because of a mismatch of demand and inventory. If your belief that more inventory can fix prices, you’re literally defining a bubble.
Fundamental support is related to income, credit capacities, and rents. If those aren’t moving, prices technically shouldn’t be.
Ethan Wu – the guy was describing a supply / demand chart and how a lack of supply with increased demand pushes prices up.
Supply / demand charts aren’t bubble charts.
In Vancouver, there are more than 25,000 empty homes, the highest percentage of any major city in Canada. But that means housing shortage and not speculative bubble?
“Foreign buyers are a myth, but non-resident purchasers of housing exist. Money launderers are probably now referred to as global liability reduction money managers.” There are hundreds of ways to funnel money into the Country. It’s called layering identities (i.e. shell companies, partnerships, Trusts, Corporations, new immigrants, or their Canadian resident nominees, Lawyers, Realtors, false Bank information peddled by Banks outside the Country, etc.) FINTRAC is the myth, while CRA concerns itself with low-level working-class online income tax submitters ( aka the real economic drivers). If you think home buyers have a problem, you should look at renters who are now 50% of residents in most Canadian Cities – fewer jobs, no wage increases and jammed by landlords who think their property is more than it’s worth.
I noticed something interesting in the article: “Canadian residential real estate prices began to outgrow credit over six years ago. The PBO calculations show credit and income no longer explain prices after 2015.” Although they only mention back to 2015 (where I think the mismatch between incomes and prices actually had taken off in year 2000, according to the BoC’s own presentation material to the Canadian Association of Business Economics from 2015), the question in my mind is: if the prices are more than what incomes + credit can support, where is the money to buy actually coming from – hmmm????? Ill-gotten gains / untaxed earnings / unregulated (including private) borrowing???? Anywhere else could it have come from? And for how long, given the ‘safe haven’ that Canada has been for money laundering according to Transparency International Canada (2019) and the Cullen Commission (2020). Given the latter, it seems that pricing exacerbations have much less to do with the ‘limited supply’ narrative, and more so ‘excess liquidity’ (no matter the source).
It would seem to me that this is enough of an indicator to propel the CRA, FINTRAC, the RCMP, CSIS, OSFI, CMHC and the FCAC (Financial Consumer Agency of Canada), at least at the federal level, into action, no? And perhaps the provincial real estate regulators too? I wonder where they have been the past 20 years?