The Canadian housing market continues to defy gravity! 🙂 According to CREA the average home price in May increased to $416,584, a 7.1% jump from a year ago. The number of homes sold also increased by 5.9% month over month, which is the largest gain in several years.
A lot of people feel concerned that this kind of growth is unsustainable. They question how prices can increase so much without personal incomes growing at the same pace. Many have concluded that we are surely headed for a correction soon.
I hope I can explain what’s going on, and why it would be perfectly normal for home prices to move even higher.
As an investor I know from experience that personal income has very little to do with purchasing power or prices. For example I spent over $200,000 on stuff in 2013 (mostly financial assets) even though my take home income last year was less than $50,000. Living in a debt based economy means we have the privilege to borrow money from other people so we may buy things even if we don’t have the cash 🙂
Local incomes also don’t account for the massive amounts of foreign money that gets pumped into the Canadian housing market each year. But what really affects the price of homes is the cost of financing. Over the last year mortgage rates went down in this country. A 5 year fixed rate term is under 3% now. Cheaper financing options means people can buy more expensive homes.
If the Bank of Canada lowers its Key rate by 1%, bond yields would fall to almost nothing, and mortgage rates would be even lower than today. You could probably get a $300,000 mortgage for 2%, which would cost a new home buyer just $6,000 a year in interest to live there. That’s cheaper than renting a comparable property! On the other hand if the Key rate increases by 1%, mortgage rates will also climb, and many people wouldn’t be able to afford a $300,000 home anymore so home prices would drop across the board. If rates don’t move at all, home prices should simply increase at roughly the pace of economic growth, which is about 2% a year.