A report from the National Bank of Canada released Wednesday afternoon says concerns over housing overvaluation in Canada are overblown as many pessimistic evaluations of the market exclude interest rates from their analyses.
A number of previous studies of home prices look at the income to price ratio or debt to income ratio. Organizations that have used these models and argue housing is overheated are the International Monetary Fund (IMF), the Deutsche Bank and Fitch Ratings. Even the Canada Mortgage and Housing Corporation (CMHC) has suggested high levels of risk exist within markets such as Winnipeg and Regina.
High household debt relative to disposable income is believed to make the housing market more susceptible to market pressures like unemployment or interest rate increases. Statistics Canada recently released fourth quarter numbers that pegged credit-market debt levels at 163.3 percent of disposable income for Canadian households. The Bank of Canada, in their bi-annual report on the financial stability of Canada, highlighted high household debt levels as a key risk.
The National Bank believes that “low interest rates have kept housing reasonably affordable in Canada,” there won’t be an abrupt rate increases soon and net in-migration into the country will keep demand up.
In major markets such as Toronto, Vancouver and Montreal, the bank argues that the share of average household income taken up by mortgage payments on an average-priced home has stayed in line over the years.
But what about rising interest rates? Matthieu Arseneau, Senior Economist at the National Bank, writes that large interest rate hikes from the Bank of Canada don’t happen over night. The central bank’s senior deputy governor recently put the neutral policy rate in the range of 3 to 4 per cent. As for interest increases in the near future, here’s what Arseneau had to say:
“If the increase in payments were spread over the period from now to 2018 and household incomes were to grow 2.5 per cent annually, the ratio would remain in the range of recent years. We note that the financial markets currently anticipate an increase of not more than 75 basis points from now to 2018. In that scenario, income growth would keep affordability essentially at its present level. Assuming no increase in incomes over this period, home prices would need to correct 11% to maintain the present affordability ratio.”
In taking this stance of housing values, the National Bank of Canada is in the company of the Conference Board of Canada, which argued in 2014 that housing bubble fears were exaggerated. Their analysis also took immigration into consideration, as well as the gradual increase of interest rates, which would give some homeowners time to adapt while Canadians with with locked monthly mortgage payments would be protected from rate increases for a number of years.