Correction would be healthy

Continued from FP1

Not only to have home prices in the GTA now absorb an unprecedented 13 years of median family income, but to have 30 percent-ish run-ups against a backdrop of a 2 per cent inflation rate, wages that are barely going up 2 per cent as well, and nominal GDP growth of around 4 per cent. This should put 30 per cent into some sort of perspective when we conclude that what we have on our hands is a near three standard deviation event.

That alone qualifies as a bubble — if you don’t like that term, then call it a giant sud. In the past, Toronto home prices went up at an annual rate of 4 per cent in real terms, in the past year they have surged by nearly 30 per cent.

Some context, however, is needed here.

First, this aggressive increase in home prices in Canada’s most populous city has come (at least in part) due to strong competition among potential buyers for comparatively scant homes for sale.

Active listings of homes available for sale in Toronto plunged 35.2 per cent YoY in March, which means that the number of months’ supply of houses on the market is a minuscule 0.65, down from 1.18 last March — for reference, a “balanced market” sees a months’ supply figure around 6.0. The average home that was put up for sale remained on the market for just 10 days, down from 16 days a year ago.

These measures of “tightness” in the market are without precedent — not even the red-hot late-1980s bubble experience could ever compete with today’s backdrop.

As well, the sales-to-new listings ratio sits well into “sellers’ market” territory at 70.8 per cent, which compares to 69.4 per cent a year ago — a ratio between 40 per cent and 60 per cent is considered indicative of a “balanced market.”

No wonder nobody wants to list their home! It’s become such a valuable asset.

But you see, this is where the danger comes in: when people start to view their house as some investment as opposed to a home — a place to raise the kids and play with them in the backyard.

A house is an asset indeed, but should never be compared to a stock or a bond or even other investable properties. It is a place to live.

Unlike a stock, which you can sell anytime and tuck away the winnings, if you sell your house, well, you still need a roof over your head.

So there are indeed some supply and demand fundamentals that are underpinning prices. Insofar as the demand is rising because people think they are investing in something hot just because of the accelerating momentum, well, these people are going to end up being pretty big losers. For if the government catches a whiff that it is now speculative fever that is dominating the uber-hot housing market, well that could very well elicit a response (as in capital gains taxes for those who sell within a year or two).

At some point, a correction would be very healthy because on the other side, owners of homes will then realize that no, they did not win some lottery, and will finally be willing to start listing their property, especially those who deep down want to sell (it could well be that the move-up buyers would like to sell but can’t afford that mansion of their dreams).

Not to mention first-time buyers who do not have the income for a down payment that any lender would consider appropriate. After all, we have hit the bizarre stage where a typical home now (and we are talking about a bungalow in Pape Village, not exactly an estate on Warren Road) would absorb 13 years of median household income.

Not even in the late 1980s, did housing get this expensive on this basis, and we know all too well how the Bank of Canada ultimately reacted and what happened next. Stephen Poloz is definitely no John Crow — though things can always change.

One caveat should be noted because what is different this time around (oh, how I hate using that phrase) is that Toronto has emerged as a world-class city and the foreign buyer is clearly having an impact.

So while Toronto residential real estate is indeed expensive for the locals, it is far less so for foreign investors, especially for Americans who can buy Canadian assets at a 25 per cent discount from a currency perspective.

As per data compiled by Global Property Guide, Toronto home prices on a U.S. dollar per square metre basis rank just 14th in the world, well behind the likes of London, New York, Paris and Tokyo.

And at the same time, if you are a family in say, Brooklyn Heights looking to buy property in Toronto it would only absorb six years of income; and if you reside in Santa Monica and feel like dipping your toes in the Toronto real estate market, it would only take up four years of your annual median take-home pay.

You see, when Toronto home prices are measured against incomes in other places of the world, it is not nearly as onerous (especially in Canadian dollar terms).

In other words, many well-heeled foreigners can far better afford what the locals can’t afford here, and housing in recent years has truly become in internationally traded asset class.

What may be needed is a very progressive tax on foreign buying of local residential real estate in the bid to cool demand and reverse the exponential surge in home prices

The home price surge in the GTA over the past year has impaired homeowner affordability to such an extent that it is basically the equivalent of the Bank of Canada having raised rates 150 basis points — actually a 200 basis point increase if you were to look at what home prices have done to affordability ratios over the past two years (so you can’t have it both ways; the price action is basically equivalent to having five-year mortgage rates closer to 5.75 per cent than the actual posted rate of 3.75 per cent).

Barring a bold move by the government to bring home prices to levels consistent with domestic economic fundamentals as opposed to income levels from wellheeled buyers from the U.S., China, and Europe, maybe it is time for the Bank of Canada to start playing a role and follow the Fed on a gradual rising interest rate path.