HIGHLY VULNERABLE

Just in time for the start of the last quarter, Canada Mortgage and Housing Corporation (CMHC) released their Housing Market Assessment (HMA) for Canada and Metropolitan Areas. This report, according to CMHC, provides economic and housing market conditions for Canada and 14 Metropolitan areas in Canada for the 2nd Quarter of 2021.

The Guelph and KW region numbers are extrapolated from the Hamilton or the GTA samples in this report, which leaves our area influenced by much larger urban reports.

The headline and the conclusion of the report states that Canada’s national housing market is highly vulnerable due to price acceleration and overvaluation, and as a result, there is increased risk and consequences of a housing market downturn.

CMHC arrives at this conclusion by looking for market imbalances in four critical factors:

Overheating: where demand is significantly stronger than supply
Price Acceleration: prices rising at an increasing rate over a sustained period
Overvaluation: where house prices differ significantly from previous levels without significant change in market fundamentals
Excess Inventories: when there is an unusually high level of vacant housing units

CMHC looks at each of these 4 factors and rates each one in terms of imbalance: low, moderate and high.

Let’s apply these parameters to the Guelph market:

Overheating

High imbalance: Demand far exceeds supply.

Price Acceleration

High Imbalance: 20%+ increase in prices in the local real estate market within a year, with a rate that is accelerating over previous years (typically we see a healthy 5-6% average increase).

Over Valuation

Moderate to High Imbalance: House prices have increased far higher and faster than wages and saving rates have been able to keep pace. What’s really driving this is the low supply, coupled with low interest rates and already high demand for homes. Until the multiple offers and bidding wars decrease, we see this as a high imbalance.

Excess Inventories

Low Imbalance: This is the least of the problems in the Guelph real estate market. In fact, the inverse of excess inventories of homes (i.e. our dramatically low vacany rate) is the prime factor influencing the other 3 factors.

It doesn’t take much to see how CMHC arrived at the conclusion that the risk level in the real estate market is high. What does this risk level rating mean, and what’s the possible impact to you and your home’s value?

Economic models want people to act in a logical and rational way.

I think we can all agree that humans aren’t always rational and logical. There is plenty of evidence that suggests we also downplay risk and the possibility of negative outcomes from our decisions. After all, it’s not like a tiger is stalking us for dinner!

The housing market has so far sustained a relatively long period of growth in sales and price. This can often (read: likely) lead to consumers having irrational expectations of continued growth. Many households that struggle to qualify or who barely qualify will buy into the market before they reach ideal conditions to purchase (savings, income, employment, etc). In other words, they need blue sky conditions in order for them to afford to purchase a home. There is little room for error.

The steady increase in prices also causes homeowners to believe prices will continue to rise without interruption, which again increases the odds of irrational spending behaviour.

Investors will also look at the steady price increases and view a real estate purchase based upon future price growth, rather than the ability of the rents to cashflow the purchase now. More investors pile into the market, resulting in a growing sense of FOMO (fear of missing out) and increasing the supply/demand imbalance.

Take this far enough and you end up with the 2007 US real estate market melt down all over again. Take away the mortgage fraud component, and the US market at the time had a lot of irrational behaviour by consumers.

Some frightening similarities to 2007 now exist in the Canadian market.

Keep in mind this report is based upon information from the 2nd Quarter of 2021. Conditions have changed significantly since then. August and September sales numbers were down significantly, and prices were still escalating but in correlation with a low number of new listings.

Our take on the current market is that it is starting to settle and become a little more rational. We intuitively know the current market is not sustainable or healthy. The challenge will be how do we get back to a more “normal” market and risk levels without significantly damaging the market.

I for one don’t want a repeat of 2007, and dealing with the financial and emotional pain that many suffered.

You can read the whole report here: Housing Market Assessment