Thoughts

January 21, 2022 | 13:26

Toronto, Calgary, Halifax Affordability: Two Out of Three Ain’t Bad

Economist

Senior Economist and Director
Economics

Sal Guatieri is a Senior Economist and Director at BMO Capital Markets, with over two decades experience as a ma... (Read more)

Sal Guatieri

Senior Economist and Director
Economics

Sal Guatieri is a Senior Economist and Director at BMO Capital Markets, with over two decades experience as a ma... (Read more)

How timely that the Ontario government’s housing affordability summit was held this week. The summit with municipal leaders led to pledges to cut red tape, speed up the development process, and spur construction of the “missing middle” to serve a growing population and tamp down on frenetic price increases. The summit was timely, in one sense, because this same week we were reminded that the province’s capital, Toronto, is one of the least affordable cities on earth. For background, the 2021 edition of Demographia’s International Housing Affordability report found that Vancouver was the second least affordable city of 92 major world cities in 2020Q3, with a median house price that was 13.0 times median household income. Only Hong Kong was worse at 20.7. Rounding out the list of super-pricey places were Sydney (11.8), Auckland (10.0), Toronto (9.9, in fifth spot), Melbourne (9.7), San Jose (9.6), San Francisco (9.6), Honolulu (9.1), and London (8.6). Of course, house prices have soared nearly everywhere since then, partly due to ultra-loose monetary policies. In the year to 2021Q3, prices in New Zealand and Australia jumped 25%, while Americans paid 16% more for a roof over their heads, according to the Dallas Fed’s database. But CREA's release this week showed that benchmark prices in the Greater Toronto Area zoomed 31% in 2021, lifting the price ratio, by our estimates, in line with Vancouver’s at more than 12. For the past two decades, Vancouver’s homes have tended to cost an extra year of income compared with Toronto—but not anymore.

To put the decline in affordability in context, 20 years ago, Toronto and Vancouver seemed reasonably priced at just over 4 and 5-times annual income. And, compared with other regions, despite recent lofty price gains of their own, price ratios in Montreal, Ottawa and Halifax have merely doubled in the last two decades to around 5, while the Prairie Provinces remain inexpensive with ratios in the 3 to 4 range in Calgary, Winnipeg and Saskatoon. True, incomes alone aren’t the sole determinant of house prices; but, most other major global cities have a bounty of wealthy households and a dearth of available land, too.

Low interest rates, of course, can improve affordability by lowering mortgage payments. The problem for Toronto is that soaring prices require buyers to get bigger mortgages with larger loan payments. Low borrowing costs are cold comfort for anyone looking to buy today. In Greater Toronto, mortgage service costs on a typical resale property would gobble up a punishing 60% of median family income at current prices, up from 48% one year earlier and just 28% two decades ago. Greater Vancouver is similarly expensive at 61%. Want to own a home and still have enough money to eat? Try Montreal, Ottawa or Halifax, where mortgage payments consume a lesser 25% of income, or, better still, anywhere in the Prairie Provinces where service costs are well under 20%.

The dramatic erosion of affordability in two regions that house one-quarter of Canada’s population means the Bank of Canada might need to walk a tightrope as it tries to rein in high inflation. Given still-solid underlying fundamentals for housing demand—a fast-growing population driven by record immigration, a large millennial cohort of first-time and move-up buyers, low and falling rental vacancy rates, and strong job growth—the GVA and GTA markets can likely withstand a moderate increase in interest rates. But the situation will become dicey if prices continue to outrace income or interest rates rise too much. For example, a two-percentage point increase in interest rates (basically back to neutral for the BoC, though longer-term rates should rise less if inflation eases) would raise mortgage service costs by another 15 percentage points to 75% of income in both regions, driving all but the most resolute buyer (with wealthy parents) out of the market. Even condos, once an affordable option (notably for investors), have gotten pricey, consuming about 36% of median family income. And that doesn’t include fees, property taxes, insurance, and heating costs. A two-percentage point rise in interest rates would send condo mortgage service costs up 8 ppts, likely driving many prospective buyers to other areas or into rental units.

Bottom Line: The Bank of Canada might have more than just inflation to worry about when it reverses policy.