Home Ownership Still Affordable

Home Ownership remains within reach for most Canadians but is getting increasingly difficult for families with household income less than $50,000, finds CIBC World Markets Inc.’s new Home Ownership Affordability Index.

Today, Canadians spend 15.6 per cent of their average gross personal income on mortgage payments, which is about the same as ten years ago. When adding in hydro bills and property/municipal taxes, it rises to about 22 per cent of gross income. However, this amount varies widely depending on where you live, how much you make and how old you are.

“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,” says Benjamin Tal, senior economist at CIBC, in his latest Consumer Watch report. “The only sub-group of households that have seen some deterioration in their affordability position is older Canadians with average income of less than $50,000. Zooming in on this group we find that on average they spend close to 60 per cent of their 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.”

While these mortgage holders have seen their affordability drop over the last year, Mr. Tal notes that, unlike the U.S., this vulnerable group of Canadian mortgage holders is on the decline. This group accounts for only 13 per cent of all mortgages in Canada, down from 19 per cent five years ago. He adds that the least vulnerable mortgage holders in Canada – those over 35 with incomes over $50,000 – now comprise some 65 per cent of mortgages in Canada, up from less than 50 per cent of the market in 2003.

“The practical implication of this finding is that the composition of the mortgage market in Canada has, in fact, improved over the past few years,” adds Mr. Tal.

In addition to percentage of income spent on mortgage payments, he also looked at house prices and interest rates in determining affordability. When it comes to prices, he finds that Canadian homes are overshooting their fair value. “The average price of a house has risen by almost 23 per cent since reaching its recent cyclical low in January 2009, and it is now almost seven per cent above the level seen before the recession. This pace of appreciation has been quicker than justified by housing market fundamentals such as income, rent or demographic changes.”

Mr. Tal estimates that, on average, Canadian home prices are now around 14 per cent over their “fair” value. This translates into more than 1.5 million houses in Canada – about 17 per cent of all dwellings in the country. He calculates that about 760,000 of these are overvalued by more than five per cent. B.C. and Alberta house prices have overshot the most with nearly one in four homes in those provinces above their fair value.

“It is hardly a surprise that British Columbia has the worst affordability reading in the nation. But note that the gap between British Columbia and Ontario is not as large as most people think. Despite strong housing markets, Manitoba and Saskatchewan still enjoy the best home ownership affordability in the nation.”

The Canadian housing market has started to stabilize in recent months. Supply is on the rise with April’s new listings climbing by close to 3.4 per cent on a smoothed month-over-month basis. The current pace of monthly increases in new units is the fastest seen since early 1990. At the same time, unit sales are now falling on a month-over-month basis following a very strong increase in mid-2009. As a result, home prices are starting to respond, with the three-month moving average growth decelerating rapidly over the past six months.

“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,” says Mr. Tal. “After all, a violent market correction needs a trigger such as the sub-prime crisis which ignited the U.S. real estate meltdown, or abnormally high interest rates as was the case during the 1991 property crash in Canada.

“Fortunately, that is not on the horizon this time around. While the Bank of Canada is very clear about its intention to raise rates soon, an array of limiting factors including a strong dollar, the end of fiscal stimulus, a slower pace of economic activity in the U.S., and a more rate-sensitive household sector suggest that rates will only climb very slowly over the next two years.

Unlike the U.S., the extended period of low interest rates in Canada did not lead to a surge in the number of mortgage borrowers in this country. In fact, the share of home owners with a mortgage fell from 54.9 per cent in 2004 to the current 53.3 per cent. In part, this reflects increased propensity of baby boomers to accelerate their mortgage payments due to these abnormally low interest rates. That phenomenon is observable across most of the country, with the only exception being Atlantic Canada.

While the number of mortgages has decreased, the average value of those mortgages has increased. Today, the average mortgage size in Canada is close to $170,000, up from $120,000 in 2004 – a 42 per cent jump in six years.

Mr. Tal’s analysis finds that the increase in the average size of mortgage has not coincided with a significant worsening in affordability. “While higher interest rates will clearly erode affordability, our detailed look at the distribution of mortgage payments as a share of income does not reveal major pockets of vulnerability. Accordingly, the most likely scenario is that higher interest rates will lead to a modest decline in prices (probably in the magnitude of five to ten per cent) in the coming year or two.

“But given relatively modest rate hikes and the current balanced affordability position, the more significant adjustment will be in housing market fundamentals that are likely to catch up with prices in the coming years-paving the way for a healthier housing market by mid-decade.”

Other key findings:
– There is no significant difference in affordability between households with fixed rate mortgages and those with variable rate mortgages. While variable mortgage holders enjoy lower interest rates, the average mortgage they carry is seven per cent larger.
– All age groups have relatively similar affordability readings despite the fact that on average young Canadians make less than older Canadians.
– Ontario and Quebec have the highest percentage of homes with mortgages at roughly 55 per cent.

The CIBC Home Ownership Affordability Index

As opposed to typical affordability measures, the CIBC Home Ownership Affordability Index looks at actual transactions (provided by Ipsos Reid) to estimate the carrying cost of owning a house in Canada as a share of gross income. This is in contrast to typical affordability measures which assume a synthetic mortgage (such as 25 per cent down-payment in today’s prices).

“Access to real data allows us to take a closer look at affordability by income group, age and even by type of mortgage,” notes Mr. Tal. “This kind of micro analysis is essential for a better understanding of real dynamics in the mortgage market.”

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