Housing correction coming: Sharp or slow?

The Canadian housing market is due for a correction, but it will likely be a slow decline rather than a sharp drop, says a report from the Canadian Imperial Bank of Commerce.

“While house prices are likely to adjust as interest rates eventually climb, the national pace of any correction is likely to be gradual,” Benjamin Tal, deputy chief economist at CIBC, said in a report released Thursday.

Still, Tal said the market will not crash abruptly because the two key triggers for a major drop are absent from the market.

“A significant and quick increase in interest rates and a high-risk mortgage market that is sensitive to changes in economic factors are not in play in Canada,” Tal said.

His report joins a chorus of other analysts forecasting a correction in the overheated market.

Capital Economics has said housing in Canada could be overpriced by 25 per cent. With the average price of a Canadian home now at $346,950, that would lop off $86,000.

Many analysts think that is an unlikely worst-case scenario. But even if home prices dipped by 10 per cent, that would amount to a $34,000 drop. Or house prices might simply stagnate for years before showing any kind of appreciation, Tal said.

“The likelihood is that prices in the Canadian market and its sub-segments are higher than what can be explained by factors such as income growth, rent and household formation,” Tal said.

“Given that, the housing market will eventually correct. The only question is what will be the mechanism of that correction.”

Affordability has been a major issue for home buyers as average prices have risen every year for more than a decade.

Nationally, prices for new homes increased by 0.4 per cent in May, led by the Toronto market, according to figures released Thursday by Statistics Canada. Year over year, new home prices in the Toronto area are up by 4.3 per cent.

Price appreciation has been even more pronounced in the existing home market, which continues to see a lack of listings.

Detached bungalows in Toronto showed the healthiest year over year price increases for all housing types at 6.1 per cent to $511,100, according to a new report by Royal LePage Real Estate Services.

In close second place were condominiums, up 6 per cent to an average of $346,407. A standard two-storey home in the GTA now costs $617,774, up 4.7 per cent from the same time last year.

“Price gains are largely due to the lack of inventory in the city,” said Gino Romanese, senior vice-president of Royal LePage.

Bungalows remain popular because of an aging demographic, but affordability has also made them the default choice for some buyers priced out of the two-storey market. Older bungalows are also a popular choice for some developers who are buying for land value to build new infill housing.

While other analysts are warning of a potential drop, the brokerage company is forecasting that prices in Toronto at the end of 2011 will be 6.4 per cent higher than last year, but still below its national average forecast of 7.7 per cent.

And there still seems to be some appetite from first-time buyers. A poll by Genworth Financial Canada said there has been a significant increase in the number of people intending to buy their first home, from 6 per cent last year to 11 per cent this year. First-time buyers have been powering the market, despite warnings from the Bank of Canada that Canadians are taking on record debt loads.

Most analysts have been saying the increases are unsustainable, but historically low interest rates have kept the market stoked.

“In many of Canada’s regional markets, we saw house prices appreciate at a significantly faster rate than wages and salaries, and this trend cannot continue indefinitely,” said Phil Soper, CEO of Royal LePage. “We expect price gains to moderate considerably in the second half.”

Tal noted that a few hot metropolitan markets drove national average prices up by 8.6 per cent in May from a year earlier. If Vancouver and Toronto are excluded, prices only rose by 3.7 per cent.