Canada’s housing market remains vulnerable despite overvaluation easing in Toronto and Victoria

Key Highlights:

• Despite improved alignment between house prices and housing market fundamentals in the previous quarter, moderate evidence of overvaluation continued to be detected for Canada as a whole in the third quarter of 2018.
• The degree of overall vulnerability remains high for Vancouver, Victoria, Toronto and Hamilton. Overvaluation is still detected in all these centres but it is easing as house prices are moving closer to levels supported by housing market fundamentals such as population, personal disposable income, and interest rates. As a result, the evidence of overvaluation has changed from high to moderate in Toronto and Victoria.
• While imbalances in Metro Vancouver’s housing market have eased in recent quarters, home price levels are high relative to local economic fundamentals, leading to CMHC’s continued detection of overvaluation.
• In Hamilton, overheating and price acceleration continue to be signaled. Despite conditions of overvaluation easing over the past few quarters, moderate evidence of overvaluation is still detected. With the inventory of completed and unsold new homes decreasing, evidence of overbuilding remains low. Housing demand is driven by population growth for the 25 to 34 age group, as it remains strong due to high immigration levels, as well as high in-migration from the GTA.
• Both Calgary and Edmonton continued to show a moderate degree of overall vulnerability in the third quarter of 2018. However, as the rental apartment vacancy rates declined, the evidence of overbuilding has eased from high to moderate in these two centres.
• Saskatoon, Regina and Winnipeg all continued to show a moderate degree of overall vulnerability in their respective markets. In Saskatoon, the inventory of completed and unsold units has stayed below CMHC’s threshold over the past three quarters. Therefore, evidence of overbuilding has changed from high to moderate. In Regina, evidence of overbuilding remained high due to a high vacancy rate and elevated new housing inventory. Winnipeg continues to see a moderate degree of overvaluation and overbuilding, and the overall assessment of the housing market is unchanged from the previous quarter.
• A low degree of overall vulnerability is sustained for Ottawa, Montréal, Québec City, Moncton, Halifax and St. John’s. The resale market in Montréal continues to be closely monitored as a result of a tightening between supply and demand, creating significant upward pressure on house prices.

Assessments for Canada and all 15 CMAs can be found in the graph located in the release backgrounder.

CMHC defines vulnerability as imbalances in the housing market. Imbalances occur when overbuilding, overvaluation, overheating and price acceleration - or combinations thereof - depart significantly from historical averages.

As Canada’s authority on housing, CMHC contributes to the stability of the housing market and financial system, provides support for Canadians in housing need, and offers objective housing research and information to Canadian governments, consumers and the housing industry.

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Quote:

"We are seeing overvaluation pressures unwinding in Toronto and Victoria, despite the fact that Canada’s overall vulnerability remains high. Nationally, overheating and overbuilding remain low. It should also be noted that price acceleration may be downgraded in upcoming reports which would lead to Canada’s overall vulnerability moving from high to moderate, provided other HMA factors do not change."

"In the Greater Toronto Area (GTA), overvaluation has changed from high to moderate due to the gaps between actual house prices and price levels estimated by fundamentals narrowing. Year-over-year growth in the average house price and real personal disposable income was modest in the third quarter of 2018 and was outpaced by economic and demographic factors, such as full-time employment and the young-adult population, which grew by 3.68 %."

"In Metro Victoria evidence of overvaluation decreased from high to moderate in the third quarter of 2018. The population of young adults, which is a key driver of household formation, increased in the third quarter adding support for house price growth. However, the support from population growth was mitigated by a slight decline in disposable income and an increase in mortgage rates."

Information on this release:

Note 1: Colour codes indicate the degree of market vulnerability. The HMA is a comprehensive framework that considers both the intensity (magnitude) and the persistence of signals of imbalances. Generally, low intensity and persistence are associated with low evidence of vulnerability. As the number of intense and persistent signals increases, the associated degree of vulnerability becomes higher.

Note 2: Overheating and price acceleration are each assessed with a single indicator. Colour scales for these factors vary between green and yellow only. Overvaluation and overbuilding are assessed with multiple indicators. Their colour scales, as well as the colour scale for the overall assessment, change among green, yellow and red to reflect different degrees of imbalances.

Backgrounder:

To obtain an accurate picture of the overall state of the housing market, it is important to consider multiple data points and lines of evidence. The Housing Market Assessment (HMA) analytical framework provides a comprehensive and integrated view that relies on a combination of indicators to detect imbalances in housing markets for several metropolitan areas across Canada, and for Canada as a whole.

Specifically, the HMA considers four main factors that may provide an early indication of vulnerability in the housing market: overheating, price acceleration, overvaluation and overbuilding. For each factor, the framework tests for the intensity (magnitude) and the persistence of signals. Generally, a situation in which we detect few signals with low intensity or lack of persistence is associated with a low degree of vulnerability. Conversely, as the number, intensity, and/or persistence of the signals increases, so does the evidence of imbalances in the housing market.

Overheating and price acceleration are each assessed with a single indicator. Colour scales for these factors vary between green and yellow only. Overvaluation and overbuilding are assessed with multiple indicators. Their colour scales, as well as the colour scale for the overall assessment, change among green, yellow and red to reflect different degrees of imbalances.

1. Overheating: Sales greatly outpace new listings in the market for existing homes.

• Moderate: Sales-to-new listings ratio lies above the threshold of overheating for at least two quarters over the past three years.
• Low: Otherwise.

2. Sustained acceleration in house prices: Fast-rising prices often indicate that expectations of future house-price appreciation may be excessive.

• Moderate: The Augmented Dickey-Fuller (ADF) test statistic stands above the critical threshold for at least one quarter during the past three years.
• Low: Otherwise.

3. Overvaluation: House prices are higher than levels supported by personal disposable income, population, interest rates, and other fundamentals.

• High: The average of the gaps obtained from a group of selected models is above the critical threshold for at least two quarters during the past year. The gap measures the distance between the actual price and the price level estimated from fundamental variables of housing markets.
• Moderate: At least one of the selected models exhibits overvaluation.
• Low: Otherwise.

4. Overbuilding: Inventory of newly built and unsold housing units and/or rental apartment vacancy rate are significantly above normal levels.

• High: The inventory of newly completed and unsold units is above the threshold for at least two quarters during the past year, while the annual rental apartment vacancy rate is also above the threshold.
• Moderate: Either the inventory of newly completed and unsold units is above the threshold for at least two quarters during the past year or the rental apartment vacancy rate is above the threshold.
• Low: None of the previous conditions is present.

Overall assessment: Assess the degree of market vulnerability considering the combination of multiple factors.

• High: More than one factor of price acceleration, overvaluation or overbuilding exhibits moderate or strong evidence of imbalances.
• Moderate: The rating reflects three scenarios. The first is when the overall assessment is red in the past six quarters. The second is when only one of the factors of overbuilding or overvaluation is assessed red for at least two quarters during the past year. The last is when one factor is showing moderate evidence of imbalances, but another factor lies slightly below the threshold.
• Low: Otherwise.

The HMA takes into account demographic, economic and financial determinants of the housing market such as population, personal disposable income, and interest rates to detect vulnerability. The framework also takes into account recent developments in both resale and residential construction markets.

The HMA was developed on the basis of its ability to detect vulnerable housing market conditions in historical data, such as the house price bubble Toronto experienced in the late 1980s and early 1990s. The ability of the HMA to detect vulnerabilities relies on the assumption that historical relationships between prices and fundamental drivers of housing markets have not changed.