Thoughts

October 21, 2022 | 13:41

Canadian Housing Affordability: Are We There Yet?

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)

Along with paying more for food, fuel, and nearly everything else, Canadian home buyers are still getting squeezed on affordability. While lower house prices have led to a minor improvement, surging mortgage rates have mostly countered. Nationwide, the median-income family looking to buy a typical property at prevailing prices and borrowing costs in the third quarter would need to spend 48% of its income on mortgage payments, down only slightly from the 49% peak in the second quarter (see chart). The last time the mortgage service ratio (MSR) was this bad was 33 years ago, when speculation drove Toronto area home prices to dizzying heights, and tight monetary policy pushed mortgage rates into double digits. The modest improvement in affordability last quarter reflects a 9% decline in benchmark prices since February’s peak, which just counters a doubling in the average mortgage rate to around 5%. The decline in prices was triggered by a dramatic U-turn in sales: from sky-high levels last winter to the icy depths of today. Prices would be even lower if sellers weren’t pulling listings or leasing their properties.

For some perspective on how costly the market still is, the current 48% MSR compares with 29% in early 2020 when mortgage rates were half today’s level and prices were about 30% lower. That deterioration speaks to the blistering 52% jump in prices in the two years to February. The two-decade average MSR is 30%, which suggests that affordability was reasonably good going into the pandemic and better than the earlier peak of 35% reached in early 2018. With variable mortgage rates certain to rise further as the Bank of Canada pulls the rate trigger again, and family income likely to be restrained by an expected modest economic downturn next year, prices will need to fall further if affordability is to come anywhere close to normalizing. An additional drop of just over 10% is expected by next summer, returning prices to early 2021 levels.

Regionally, prices are already down about 20% in some cities (Cambridge, Kitchener, Waterloo) that were juiced by teleworkers flocking to once-affordable regions before the pandemic. Not anymore. What distinguishes the recent housing frenzy from earlier ones is the breadth of the gains, notably in small cities and rural regions not known for supply shortages. But the combination of the ability to work from home and record-low mortgage rates pushed demand well beyond the capacity of homebuilders who were struggling with labour and material shortages and zoning restrictions. MSRs in Hamilton and Victoria jumped to over 50% from 30% in early 2020, while Brantford and the Niagara Region nearly doubled to just under 50% from 25%.

Several major cities are still relatively affordable. Montreal, Ottawa, and Halifax all have MSRs in the low 30% range, though this is up from less than 20% in early 2020. The bigger challenge for these regions is that buyers need to qualify for a federally regulated loan at rates that are 2 ppts above the contract rate, putting qualifying MSRs just under 40% and thus shutting many prospective buyers out of the market.

Affordability remains especially good across the Prairie Provinces and parts of Atlantic Canada and Quebec. Saskatoon, Edmonton and Winnipeg each have MSRs in the low 20% range, while Quebec City and St. John’s are even lower. Most buyers in these cities would have little trouble passing the stress test. These cities can expect a limited price correction compared with Ontario and British Columbia, where the earlier mania was more feverish.

And then there’s Vancouver and Toronto, home to a quarter of the nation’s population and some of the priciest property in the world. Even after price declines of 6% and 9%, respectively, MSRs are as eyepopping as ever at over 70%, up from the mid-40% range in early 2020 and mid-30% range in 2005. That’s what happens when prices outpace income by a factor of two in the past 17 years, taking ratios to a nosebleed 11:1. Even condos are out of reach for most median-income families with MSRs of around 45%.

Bottom Line: Canadian house prices likely need to fall further before buyers can afford to return en masse. Amid supportive immigration and a tight rental market, the correction should remain orderly, so long as mortgage and jobless rates don’t rise much more than expected.