Concerns about the health of Canada’s housing market continue to weigh heavily on the minds of policy makers and pundits alike. Economic vulnerability caused by imbalances in Canada’s housing market was noted as one of the greatest concerns among economic policy makers in Bank of Canada’s June 2016 Financial System Review.
However, there are mixed signals as to whether or not Canada’s housing market is out of balance, as the following facts indicate.
Firstly, despite the measures being taken to cool the market, prices continue to rise.
For July 2016 the average house price grew by just under 10% year over year with the majority of that growth coming from the scorching-hot housing markets of Toronto and Vancouver.
A number of bank CEOs and economists have expressed concern over the frothy markets that exist in those cities. It has led to Bank of Nova Scotia (TSX:BNS)(NYSE:BNS) moving to reduce lending in those markets so as to reduce the degree of risk in its mortgage portfolio.
Secondly, the average price for a house in Canada has grown to $481,000 according to the Canadian Real Estate Association–an increase of 42% above the 2006 price of $338,900.
Even after accounting for the growing wealth of Canadian households, it brings into question its affordability.
Thirdly, the affordability of housing continues to fall.
According to Statistics Canada, the average annual household income in 2014 was $78,870; with an average housing price of $481,000, this puts the national price-to-income ratio at just over six times. Only five years earlier, the average house price only represented 5.8 times the average annual household income.
Finally, there are signs the market is starting to cool and returning to a point of equilibrium.
The July 2016 national home sales dropped by 1.3% compared to June; the greatest decline occurred in Metro Vancouver, where sales plunged by 27%. The national sales-to-new listings ratio for July fell for the second month, easing to 61.6%, or almost 4% lower than its May peak.
According to the Canadian Real Estate Association, this indicates that the market is moving back to equilibrium with a ratio of 60% or less representing a market balanced between supply and demand.
The state of Canada’s housing market continues to garner considerable attention as people fear that high levels of household debt and a growing bubble will eventually trigger a meltdown. This would have a significant impact on Canada’s banks with each of the Big Six heavily exposed to the residential property market.
In the case of Bank of Nova Scotia, Canadian residential mortgages make up 45% of the value of its loan book, whereas it is 47% for Toronto-Dominion Bank (TSX:TD)(NYSE:TD).
However, an important backstop that would mitigate the impact of a housing bust is compulsory mortgage insurance on all loans with a loan-to-valuation ratio, or LVR, of greater than 80%.
Bank of Nova Scotia has 59% of its mortgages insured, while its uninsured mortgages have a conservative LVR of 50%. Toronto-Dominion has a similar proportion of its mortgages insured and an average LVR of 58% for its uninsured residential mortgages.
This means that while a housing crash will certainly hurt the banks, they are capable of surviving without catastrophic losses to their businesses.