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Real estate is really better here, but concerns remain

It isn't often Canada can claim bragging rights over its southern neighbour. Despite ongoing global economic uncertainty that continues to pummel the U.S. real estate market, the news is significantly better north of the border. But it's too soon to claim ultimate victory: Looking beyond the most recent figures reveals cause for longer-term concern.

After adjusting for inflation, American home prices dropped 7.5% year-over-year in the third quarter. The latest slip means the typical U.S. house now sells for 30% below its 2005 valuation. Americans continue to stay away from real estate because they're spooked by stubbornly high unemployment and tightening credit. Add in a huge property glut from the last three years of disastrous economic news and it's increasingly likely the situation won't reverse itself for a number of years.

Canada, on the other hand, is in relatively good shape. Inflation-adjusted prices rose 4.8% in the same year-over-year period and continue to hover near all-time highs. Flattening prices through November point toward a balanced market, with continuing historic-low interest rates serving to pull in new buyers. Even with growing worries that the questionable strength of the economic recovery could put a damper on new hiring — and housing demand — into 2012, the situation remains far more stable in Canada than in the U.S. and other countries.

"We've been of the view for some time that the most likely scenario for the Canadian housing market is one of stable home resale activity and prices in the coming year," says Robert Hogue, Senior Economist, Economics Research with the Royal Bank of Canada. "This is based on the grounds that economic growth in Canada will be sustained (i.e. no double-dip recession) and that the current exceptionally low interest rates will be unwound gradually."

Hogue says despite ongoing global economic headwinds, Canada's real estate market will continue to largely escape the resulting turbulence.

"Developments in global financial markets since July have somewhat altered the economic landscape but, perhaps surprisingly, not the bottom line for Canada's housing market," he says.

"While the global financial market turmoil has prompted us to revise our economic growth projection lower in September (taking 2012 down to 2.5% from 3.1%), we now expect interest rates to remain low for a longer period of time (until the middle of 2012 in the case of Bank of Canada's overnight rate)."

The extra boost from lower interest rates will compensate for the extra drag from slightly lower household income growth and more fragile consumer confidence, Hogue adds. The bottom line impact is negligible change to real estate demand through much of 2012.

Warning signs for the market

Even so, the International Monetary Fund is sounding a warning that the relatively good times in Canada's real estate market could have a dark side. The IMF's annual report on the Canadian economy says average home prices are 10% above where the models suggest they should be. Record household debt levels — currently running at 150% of disposable income — suggest Canadians could soon have no choice but to rein in spending.

While the Canadian economy has largely escaped the turmoil currently gripping Europe, it remains vulnerable to events beyond its borders. As Europe fights to stave off debt-related collapse, the U.S. recovery continues to stall and Chinese growth rates return to earth after a long, hot run, Canada's economic growth projections — always a prime driver of real estate demand — aren't as clear as they would be otherwise. Unable to rely on shaky export prospects, Canada's economy will increasingly depend on internal drivers. The dimming external prospects largely explain why the RBC economist is warning Canadians against becoming too complacent in the long-term.

"Even before the increase in global tensions since late July, we were drawing attention to the fact that the Canadian market has had a significant run in the past decade or so, that affordability is on a deteriorating path and that household indebtedness is high, and these factors make the Canadian housing market susceptible to a downward correction in the face of a negative shock," says Hogue. "This susceptibility certainly is no lesser now."

Carmi Levy is a London, Ont.-based independent technology analyst and journalist. carmilevy@yahoo.ca

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