While economists and weather forecasters regularly make forecasts that are widely off the mark, from an economic perspective there are two that stand above the crowd. First, prior to the collapse of oil prices in 2009 and again in 2014, a number of widely-quoted economists and commodity analysts were calling for oil prices to reach $200 a barrel in “a heart beat”.
The second and, for the purposes of this article, more relevant missed forecast relates to the collapse of the Canadian housing market which analysts have regularly heralded since the last recession.
The principle factor which led to the collapse of oil prices and which, thus far, has contributed to the rapid escalation in house prices has been supply. Fuelled (literally) by the dramatic increase in the supply of oil (primarily from the U.S. Midwest), oil prices (in real terms) hit a fourteen year low in the first quarter of 2015 and are well below their 42-year average of $56. In the case of housing, an artificially induced shortage of single-family homes has driven house prices in Toronto and Vancouver up by over 20 percent year-over-year in November.
Despite the evidence that the upward pressure on house prices was, in large part, due to a shortage of new single-family dwellings, the federal government, or its housing agency CMHC, has made five futile attempts between 2008 and 2016 to cool housing demand by making it more difficult for home buyers to qualify for government insured mortgages.
Faced with the above noted year-to-date acceleration in house prices and a near stratospheric ratio of household debt to incomes, the federal government announced on October 3, 2016, four "preventative measures for a healthy, competitive and stable housing market". Consistent with previous government initiatives, these measures made no attempt to increase the supply of affordable single family homes which, as the Bank of Canada noted in its latest (December 2016) Financial System Review, is restricted by residential land use regulations and lengthy and uncertain project approval timelines in major urban centres.
As a result of the federal government’s announcement of further measures to curb housing demand by restricting access to mortgage insurance, a number of analysts have scaled back their forecasts of home sales and house prices in 2017.
After posting year-over-year increases of 5.5% and 4.4% in 2015 and 2016 respectively, the Royal Bank now expects existing home sales to retreat by -11.5% in 2017, their largest drop since they tanked by -17.2 % during the 2008 recession.
However, despite this "mini crash" in sales, RBC anticipates that average house prices will still increase by 1.6% next year after posting a 9.5% y/y increase in 2016. While not as downbeat on sales as RBC, the Canadian Real Estate Association (CREA)’s most recent (December 2016) forecast calls for home sales to retreat by -3.3% in 2017, somewhat more than it projected in September (-0.6%). Regarding house prices, CREA now expects average house prices to contract by -2.8% in 2017 compared to its September forecast of -0.2%.
While there is a risk that the recently introduced mortage regulations will cause both home sales and house prices to retreat in 2017, most of the fundamental drivers of housing demand remain firmly in positive territory. First, although housing affordability has deteriorated over the past several quarters, this deterioration is primarily concentrated in Toronto and Vancouver.
Second, conventional 5 year mortgage rates at 3.7% remain close to the record low of 3.66% they reached in June of 2016 and few expect they will increase significantly in the near term. Third, in the absence of any material easing in the land use regulations which are restricting the supply of single-family dwellings, especially in Toronto and Vancouver, pressure on prices is unlikely to abate. Finally, the volume of home sales should continue to be underpinned by stronger growth of total employment and a persisting net inflow of international migrants.
Collectively, these strong fundamentals should once again disappoint the doomsayers by postponing the next housing market crash for at least another year or two.