By Tom Bradley

In this, the 2nd of 3 posts on the Canadian housing market, I address valuation.

Near-zero interest rates are absolutely driving this market. The problem is, low rates are transient, while purchase prices live on forever.

In today’s terms, transient means that it’s almost certain new borrowers will renew their 3 or 5-year mortgages at a higher rate 3 to 5 years from now (I stole that line from Rob Carrick of the Globe and Mail).

As for price, the measures used to value residential real estate haven’t improved despite the good news I reviewed in my last post. They’re still screaming OVERVALUED.

Prices vs. the long-term trends and inflation – House price increases have been running well above inflation and the long-term trends.

Affordability – Depending on the region, the affordability ratios range between ‘average’ and significantly ‘overpriced’. These ratios, however, are highly sensitive to mortgage rates. Higher rates will mean less affordable houses.

Buy vs. rent – These calculations still favour renting.

Consumer debt levels – It’s well documented that too many Canadians have stretched to buy their house or condo, and as a result, have limited ability to deal with higher interest rates and/or job losses.

Housing starts vs. household formation – After years of building houses at a rate well in excess of household formation, we’re seeing some improvement on this statistic. Housing starts have slowed.

Canada vs. U.S. – The U.S. real estate market has bounced back, dramatically in some regions, but prices south of the border are still significantly below Canada.

Despite reassuring headlines and the usual spring enthusiasm, the reasons to be concerned about the Canadian housing market have not gone away. Indeed, if we broaden the context and consider some macro trends, it could be argued that the outlook is even worse. Certainly the market’s dependence on near-zero interest rates and accommodative bankers (“Would you like a home equity loan with your cheeseburger?”) is not good. Neither is the fact that the Canadian economy, which is dependent on resources, home building (hmmm) and unrestrained government spending, is now lagging the U.S. And on the demographic front, we are now entering an extended period when the number of people entering the home buying cohort (over 25 years of age) is declining while the number entering the selling phase of their life (65 plus) is steadily rising (here come the boomers).

My conclusion based on the cold, hard valuation numbers: Despite the spring activity and warmer headlines, it’s not a time to be complacent. In Part III tomorrow, I’ll tell you what I really think.