A “froth” market exists when the value of an asset becomes overvalued or overvalued.
This condition can lead to a bubble that eventually bursts, causing the house to fall.
Robert Cavic, chief economist at BMO, says the Canadian housing market has been “frothy”.
However, with interest rates rising, Kavcic sees some buttons starting to disappear.
“Froth is out of home prices, just as in a number of other asset classes that excessive stimulus policy has boosted,” Kavcic wrote in a May 20 post.
He explained that home prices in the country have historically grown by about three percent annually since the early 1980s.
Growth “roughly” reflects inflation, wage growth and lower interest rates.
Kavcic stated that “in the current episode, even with inflation accelerating to its highest levels in several decades, real home prices have risen by more than a third in a two-year period, and they have clearly stretched beyond the underlying long-term growth trend.”
As of the first quarter of 2022, the BMO economist suggested that the market had “peaked,” with prices “38 percent above trend, the largest deviation in the past 40 years.”
In particular, “most of the scum has accumulated in the suburbs and suburbs of Toronto.”
Kavcic stated that “other markets, such as Vancouver, Montreal and Atlantic Canada have foam, but not as far as southern Ontario.”
Then something happened.
The Bank of Canada handled consecutive rate increases set in March and April of this year.
The cumulative rise of 0.75 percent raised the central bank’s interest rate to one percent.
As a result, “the market is experiencing a sharp decline in some areas,” Kavcic noted.
“So, when we talk about housing correction, it is not a question of whether, but where, how much, how much and for how long?” BMO Economist Books.
On May 16, the Canadian Real Estate Association (CREA) reported that home sales declined month-on-month in April 2022.
National home sales fell 12.6% in April compared to March 2022.
CREA reported that the slowdown in sales “put monthly activity to the lowest level since summer 2020”.
The house price index fell 0.6 percent month-on-month in April, but is still up 23.8 percent year-on-year.
CREA stated that the decline was “the first monthly decline since April 2020”.
On May 20, Kavcic noted that “market psychology and affordability have already been tested by the 0.75 percent ‘tightening’ of interest rates by the Bank of Canada.
Kavcic expects “another 125 basis points by year-end,” or an additional 1.25 percent increase.
He explained that such a measure would mean that current mortgage rates of around 1.5 per cent would rise in the range of 3.75 per cent to 4.5 per cent.
Kavcic stated that “the difficulty is that home prices are already outpaced against income levels and interest rates at those very low, so the upward movement is going to be much harder to swallow.”
The BMO economist went on to suggest that 10 percent to 20 percent “will be needed to lower prices, all else being equal, just to maintain current (extended) affordability”.
However, “the mileage varies by market and region.”
Is crash coming?
“We believe the fundamentals remain in place to ultimately support the market,” Kavcic wrote.
First, “demographics is a legitimate source of demand.”
He was referring to millennials and recent immigrants to Canada.
“There will be buyers waiting; but prices need to make sense in the high-priced world,” Kavcic wrote.
Also, the higher construction costs “will put a floor on resale prices at some point, perhaps sooner rather than later.”
Also, the policy of stress testing for borrowers “isolated the financial system from high interest rates, at least from the perspective of ability to pay”.
To illustrate, Kavcic said mortgages at 1.5 percent must meet the repayment threshold of 4.75 percent to 5.25 percent.
“This will not save home prices from falling (they are driven by the rate you actually pay more than the back room account), but it does provide good insurance that payments will continue to be made, especially with the tight labor market,” he explained.
Kavcic does not believe that “what has now become an asset price correction can develop into prolonged economic-driven weakness.”
“While a cooler housing market will affect economic growth, we believe this will be largely an asset price phenomenon, with the underlying fundamentals finally being put in place, and the financial system well protected,” the BMO economist wrote.