Canadian home sales dropped by about 4% in October, but that doesn’t mean it’s time for homeowners to panic. Vitali Mossounov and James Hunter, TD Asset Management, discuss the six factors used to assess the health of the Canadian housing market and explain why we aren’t in a bubble.
Good to be here.
Yeah, thanks, Sarah.
I want to start with your framework. There are six factors used to identify a housing bubble-- real estate as a percentage of GDP, real estate as a percentage of jobs, household debt, residential investment, the downside to GDP, and housing prices. Today, we're looking at one of those factors-- housing prices. And in this chart, price patterns are shown on a 1, 3, 5, and 8 year time horizon. The black line represents home prices in Canada. The yellow line is our closest peer group, Australia and New Zealand. The green line is the US, and the other two comparisons are the Eurozone in gray, and Scandinavian peers in blue.
The focus here is price appreciation, because Canadians are worried. Yes, we are seeing sales slow. But prices are still going up, which we see in the first point of your chart. Why aren't you worried about that?
Well, many people often throw the word bubble around. And we'd be very careful with that. So bubble implies that price patterns have somehow detached from fundamental realities. And people often use that term without really the weight of empirical evidence behind it.
Now, as you mentioned, price appreciation in Canada has been very strong at over 10% per year in the last few years. However, that's not enough information for us to go on. And we thought we'd look at a few more pieces to complete our analysis.
One thing that we did was pull up housing data going back a little further- five years and eight years. Then, we took that price appreciation data for Canada and compared to it to other peer nations. So these are advanced countries with high living standards and robust economies. We're talking countries like Australia, New Zealand, and the Scandinavian countries.
And what we found is that actually, as you go back far enough, price patterns tend to converge between these nations. For example, since the financial crisis, the average price appreciation in Canada has been about 6.7%- certainly robust, but actually, only marginally higher than Australia, New Zealand, and the aforementioned Scandinavian countries.
Now, there's two factors as to why we're not particularly worried. First, Canadian cities consistently rank as the most livable places in the world. The Economist Intelligence Unit has pegged three of the top five places to live to be right here in Canada. And data from Mercer, I believe, gives us four of the top 25 rankings.
So from a holistic perspective, it certainly seems that there's no good reason as to why home prices in Canada on a per square foot basis should be any less than other world class locations. And secondly, Canada has excellent population demographics. Over the last five years, we've had an average of 1.1% population growth, well in excess of the United States and the Eurozone countries. And our labor force has been more than able to accommodate that extra growth in number of people. So what you've actually seen is the decline in the unemployment rate by about 100 basis points over that time period.
It's not just prices going up, though. So let me ask you, James. There are three things your analysis shows. The first is that household debt is growing, affordability is deteriorating, and residential investment is now growing at a slower pace. So what makes you think we aren't headed for a crash?
Yeah. Household debt continues to reach all time highs in Canada, at about 175% of disposable income. Of course, the key driver behind that trend has really been low interest rates. As you say, affordability is becoming an issue in Canada's major cities. It's something we'll continue to hear about as prices increase. But when we looked at the data, what we found is that Canada is actually in the middle of the pack compared to its global peers in terms of household debt.
So while it's true, for example, that the US and Europe are better off at about 110%, we're actually doing better than oceanic and Scandinavian nations. Both those regions clock in at about 200%. Now, Vitali just mentioned a couple of reasons why we're not headed for a housing crisis. And I'll add a couple of my own. So the first is residential investment. And that really refers to the construction of new dwellings- so homes, apartments, condos. And so if you look at its contribution to GDP growth, it's been growing slowly and steadily since the end of the financial crisis.
It's actually been growing at the same rate as in the US, and a little more slowly than oceanic and Scandinavian peers. So we really take comfort from the fact that Canada's in the middle of the pack in terms of residential investment.
So the second piece is housing starts. And we know that that can be an important economic indicator. It can signal excesses in the housing market. So when we look at housing starts, they've just started to ramp up to elevated levels over the summer, at about 220,000 units on an annualized basis. But looking at the numbers, we know that previous housing booms have lasted many years at those levels, not just a few months. So our view is actually that construction activity has room to run.
On the whole, I'm going to- based on both your responses- say not as catastrophic as we may have thought. But what are some of the trends or things that could derail this trend, I should say?
Well, some of the key factors can change over time, for sure. Some of the usual suspects would be higher interest rates or significant job losses. And we haven't seen any consistent signs of that on the horizon yet. But it can be helpful to quantify the downsides of the economy if that were to happen. So when we look at previous housing downturns, for example, Canada in the early '90s, or the US in the late 2000s, what we found is that residential investment fell about 25%.
So then if you take that scenario and you apply it to Canada's current level of GDP, we estimate that you could lose about two to three percentage points of GDP growth. And that would clearly be a big hit to the economy as a whole. But I don't want to end on a point of doom and gloom. And I know that Vitali has a few closing thoughts.
Putting it all together, it's certainly true that home prices have been rising and debt levels are higher than where they've been before. But at the same time, we're finding very similar patterns with peer nations. Overall, we think that the level of home prices in Canada is actually quite reasonable when you take into account the combination of strong economic growth, good labor force characteristics, and the healthy and well-developed financial market. Overall, if we continue to see the same rate of price appreciation over the next couple of quarters- and even years- then we'll begin to get concerned. But at this stage, we think there's room for caution, not alarm.
Vitali, James, thank you for bringing your framework and joining us today.
Thanks a lot, Sarah.