28 Apr
The current situation of the housing market has occupied many Canadians because home prices have been increasing faster than inflation for decades and have gained further acceleration during the current pandemic, further adding pressure on housing affordability. This creates a debate regarding whether the current market is in a bubble or not. If it is, then house prices will decline when the bubble bursts. This can be unnerving for homeowners but a light at the end of the tunnel for prospective buyers.
It is important to note that an economics confidence should never be confused with certainty because there are various factors involved which can create an imbalance in an economic equation. Similar is the case with housing prices because one cannot say with certainty which factors are really impacting housing prices. Careful economists usually point to the limitations of their models, often adding the phrase “all other things equal” to their conclusions. This is because there is always some factor that are driving home price which they have not considered, in which case things are not equal at all.
An important aspect to note is that rapid housing price inflation is not unique to Canada. There are at least two important drivers of housing prices common to all countries that are receiving less consideration. The first factor is pertinent to population growth and failing to develop sufficient housing to accommodate new arrivals in Canada will translate into further pressure on home prices. The Ontario Housing Affordability Task Force released a report and, in their report they m provided recommendations to allow greater housing density in established neighborhoods and requiring higher-density buildings in the suburbs.
Even if exact number of houses were built to accommodate rising demands, the price of existing homes would still show an upward trend. The reason for this upward trend is that time is money. Because the population of a city is increasing, constantly prompting the construction of new homes in suburb areas, will put each new homeowner further away from the city centre. The trip to downtown areas would become longer for each homeowner who is living farther away. This results in the prices of homes increasing that are closer to downtown areas because distance and time spent to reach downtown will be shorter. In such cases, new buyers would be willing to pay more to live closer to the centre of the city. Hence, as a city grows outward, the prices of existing homes closer to the centre goes up.
The second home price driver is related to low interest rates. Low interest rates encourage more people to become homeowners earlier in their lives, boosting demand and causing prices of existing homes to be higher. The same situation can be found in Canada as well where, because of the pandemic, the interest rates were quite low, which resulted in more and more people becoming homeowners at an earlier stage of their lives. Furthermore, many borrowers took out a second mortgage in order to assist their children in becoming homeowners.
The net effect of these two contrary forces is difficult to forecast, however, if the outcome is a decline in prices, then it indicates that Canada’s housing market is not in a bubble. In a bubble, prices rise – and later fall – for purely speculative reasons, but not because of changes in fundamental price drivers.
Moreover, Canada has planned the immigration of more than 400,000 people over the next few years which suggests a future price correction could follow the same pattern. Even if there was an unexpected drop in housing prices causing long-term owners to feel less wealthy, the associated slowdown in economy would be temporary.
