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Home prices may have reached their peak

Home prices continue to push to new post-recession highs but experts worry that recent increases may be concealing signs of a substantial decline, experts say.

Home prices continue to push to new post-recession highs but experts worry that recent increases may be concealing signs of a substantial decline, experts say.

Statistics Canada’s new housing price index rose 0.4 per cent in May from April. Year-over-year, the index was up 1.9 per cent from May 2010h, following an identical increase in April.

Meanwhile, a Royal LePage house price survey and market forecast found that Canada’s residential real estate market saw sizable year-over-year price increases in the second quarter.

The price hikes were evident across all housing types surveyed, with the national average price of a detached bungalow rising the most — 7.5 per cent year-over-year to $356,625. A standard two-storey home rose 6.1 per cent to $390,163 and the price of a standard condominium 3.5 per cent to $238,064.

“In many of Canada’s regional markets, we saw house prices appreciate at a significantly faster rate than wages and salaries, and this trend cannot continue indefinitely,” said Phil Soper, president and chief executive at Royal LePage.

“We expect price gains to moderate considerably in the latter half of 2011, which should reduce the stress associated with purchasing a new home,” Soper said.

Royal LePage said signs of moderation, although they vary from region to region, are beginning to become apparent and the average price of a home is expected to end they year 7.7 per cent higher than at the end of 2010. Sales volume nationally is forecast to decrease marginally by two per cent over the same period.

Economist David Madani at Capital Economics said the Royal LePage report underscores some of the concerns he has about the state of Canada’s housing market, as price barometers from several sources shows price increases are out of step with market activity.

The Canadian Real Estate Association found the national average price in May gained 8.6 per cent to $376,817 and the most recent data from the Teranet index showed prices were up 4.4 per in April.

It’s reasonable to guess that prices could be close to a peak as they are testing the limits of affordability, but people have been entering the market predicting prices can only go higher, he said.

“For some people housing may feel like a now or never proposition so this is maybe is enticing people to pay these astronomical prices relative to income for housing and of course to do this they’re digging deeper and deeper into debt.”

Economists suspect that prices will drop off when interest rates rise, further putting pressure on affordability.

Home sales activity has dipped in the second quarter as consumers rein in their finances and spending and following a busier than expected first quarter. Sales during that quarter were driven higher by as some buyers rushed in to beat new mortgage rules that shortened the amortization period, as well as by a surge in activity in British Columbia.

“Vancouver, and specifically certain neighbourhoods in the lower mainland of British Columbia, remains an anomaly, as investment from outside of the country continues to support higher price levels,” Soper said.

Home sales for the full year are expected to be slightly weaker than they were in 2010, when an exceptionally strong first quarter, driven by a rebound in demand and emergency low interest rates, skewed the numbers higher.

Despite the drop off in the number of buyers competing for houses, which usually eases pricing pressures, prices tends to lag sales by a few quarters as sellers try to hold out for a bit before resorting to a lower asking price, bringing sales down.

“What you’ll see at the peak of the market, is maybe listings rise a bit or the time that property sits on markets starting to stretch out, prices might hold up but with the lag they’ll start to come back down again,” Madani said.

The sales-to-new listings ratio, a measure of market balance, stood at 52.1 per cent in May, indicating a balanced market, according to CREA data.

The Royal LePage survey predicts that year-over-year prices will rise modestly in the third quarter and come in flat in the fourth quarter.

“We believe we are past the period of peak house price appreciation,” Soper said.

But with some economists now saying homes are about 10 per cent overvalued, there could be a much more substantial decline than the “miraculous soft landing” that most observers are predicting, said Madani.

“History, unfortunately, hasn’t been as kind.”

Madani pointed to the mood of economists in the U.S. just before the 2008-2009 housing crash as an example. At first observers predicted a slight moderation, then thought there was a bubble in one or two regions “ and then of course everything hit the fan,” he said.

However, Benjamin Tal, deputy chief economist at CIBC, believes that Canada’s housing market is becoming so segmented that traditional measures like average prices are increasingly irrelevant.

“Glancing at popular metrics such as the price-to-income ratio or the price-to-rent ratio, it is tempting to conclude that the housing market is already in clear bubble territory and a huge crash is inevitable,” he wrote in a report.

“Tempting, but probably wrong. When it comes to the Canadian real estate market at this stage of the cycle, any statement based on average numbers can be hugely misleading. The truth is buried in the details—and there the picture is still not pretty, but much less alarming.”

Tal notes that while Canada’s average house price rose 8.6 per cent in May, the figure slows to 5.6 per cent when removing Vancouver. If Toronto is also removed, that increase drops to 3.7 per cent.

“But even a multi-dimensional market can overshoot — and the likelihood is that prices in the Canadian market and its sub-segments are higher than what can be explained by factors such as income growth, rent and household formation. Given that, the housing market will eventually correct. The only question is what will be the mechanism of that correction.”