The main corrective force currently at work in Canada’s hottest markets – Vancouver, Calgary, and Edmonton – is affordability. As it erodes in the wake of large home price growth that has significantly outpaced household income growth, it dampens housing demand for new and existing homes. Sales in Vancouver have already dropped significantly from a peak in 2005. Meanwhile, sales in Calgary seem to have peaked this year, and a slowdown in sales is likely not far behind for Edmonton. Declining sales-to-new-listings ratios suggest a turning point for price growth in these markets. Out east, the affordability trend is mostly sideways, and markets are experiencing more balanced conditions.

Recent increases in mortgage rates have also put a dent on affordability, irrespective of market location. While still low on a historical basis, mortgage rates are sitting at their highest level in five years. From February to July, Government of Canada 5-year bond yields, which anchor standard mortgage rates fixed for the same duration, increased by roughly ¾ of a per cent. Our outlook for Government of Canada bond yields is that they will float upwards heading into 2008 to settle around 4.65% by mid-2008. For those with shorter term fixed rates who are looking more at the front-end of the yield curve, we expect the Bank of Canada to bring its overnight target rate to 4.75% by the end of this year, a 1/4 of a per cent increase from its current level.

Affordability is declining, but the cooling in housing activity should proceed in an orderly fashion. The fundamentals of the Canadian economy, and the economies of large metro areas, remain good. The pace of job creation in 2006 was surprisingly high and remains solid again this year to date. While net job creation is likely to slow in 2008, employment should keep growing at a decent pace – see table. The challenge for eastern markets is for service industries to keep creating more than enough jobs to compensate for any further potential losses in the manufacturing sector. Out west, the slowdown in job creation is mostly tied to resource sector activity simmering down from the recent boom. Furthermore, more flexible mortage products with longer amortization periods to 40 years help mitigate the impact on affordability and contribute to an orderly slowdown.

Vancouver – A balanced market within sight

Existing home prices are expected to post a 12% gain from last year. TD Economics forecasts that this softening in price growth will continue into 2008, where the yearly average resale home price gain is expected to come in at 7%.

What lies beneath this outlook? First, a higher number of existing homes listed for sale. This dampens new home demand and helps ease relative demand pressures for existing homes. As more homeowners look to lock in price gains from recent years, listings are expected to continue feeding supply more than enough to meet demand.

The second main driver behind our forecast for softer price growth lies on the demand side: affordability. Not only is affordability poor on a level basis, it has been deteriorating significantly in the last couple of years. Typical mortgage carrying costs for a median-priced home in Vancouver required close to 10 percentage points more of the median market household income in 2006 than it did a year earlier. As the lagged effect of this significant deterioration works through the system, it will continue to dampen demand going forward.

Whereas sales might increase at most 2-3% from last year, new listings are expected to increase by twice as much in per cent terms. After exhibiting the characteristics of a strong seller’s market since the turn of the decade, Vancouver’s market is heading back towards more balanced conditions (see textbox for discussion of overall market balance measure). Indeed, the demand-supply ratio for Vancouver’s housing market is inching towards the balanced market range of 0.4-0.6.

On the new home market front, housing starts continue to downshift after having peaked in 2004. However, the number of starts should remain lofty throughout the forecast horizon. A lean inventory of completed but unabsorbed units, along with high construction costs, have helped continue an upward trend in new home price growth that is six years long and still running.

Residential construction continues to face challenges like a shortage of skilled trades, high land prices, and increasing competition for resources from the non-residential sector. This is illustrated by the recent increase in building permits that has not been accompanied by rising starts to match. In other words, builders have purchased permits, but have not broken ground. Unless sufficient resources can be made available to catch up with building intentions, this is likely to put continued upward pressure on new home prices and to further erode an already strained new home affordability.

In terms of resale home price growth, Vancouver was the first western market to cool from its peak of 20%. Thankfully, the easing from such a break-neck pace of growth is proceeding gradually. Demand remains well supported by a pace of job creation that only Alberta has been able to outmatch. But Vancouver’s job market is also less vulnerable to downside risks tied to the volatile resources sector, and employment growth is expected to outpace the Canadian average by 2.5 times. Therefore, we are expecting the market to remain relatively tight. But as the supply of homes continues to grow, while demand softens as a result of eroding affordability, price growth should head back down towards a more sustainable pace.

Still hot, but cooler in Calgary

What’s happened to the average resale home price in Calgary since 2005 is nothing short of phenomenal. Year-over-year average resale home price growth has averaged 25% since then. In June 2006, Calgary overtook Toronto as Canada’s second most expensive major metro market behind Vancouver, and has never looked back since then. The price gap between Calgary and Toronto is expected to come in above $60,000 on average this year. As a consequence, Calgary’s home affordability has eroded considerably.

On a level basis, affordability in Calgary remains decent since prices started from a much lower base than say Vancouver or Toronto, while income is also higher. But the price surge has also meant that since the second quarter of last year, Toronto is more affordable, when affordability is measured across all housing unit types.

As for the new home market, year-to-date housing starts are down by more than 20%, which was expected and is welcome given their unsustainably high levels of a year-ago. We still expect starts to remain at a historically high level, of close to 15,000 units per year over the forecast period. Most of the pare-back should be concentrated in single-detached units. The projected decline is positive since it should help to mitigate the risk of a supply glut forming in the coming months.

On the demand side, sales are still up year-to-date from the same period last year, but the modest 3.4% gain actually confirms a cooling off in sales growth. From yearly increases in sales of 19% of 2005 and 5% last year, this year’s gain is expected to come in at 2%. We also expect sales to pare back by about 5% next year as poor affordability puts a dent in demand. Even if Calgary’s market conditions have been firm seller conditions, the market balance has improved in 2006 and we expect this trend to continue. More listings on tap, along with softer demand, should combine to help Calgary’s housing market ease off the pedal gradually rather than slam on the brakes.

In this regard, a solid economic backdrop should help. Calgary’s economy is expected to grow at a slower, more sustainable pace through the forecast horizon. Energy prices are likely to stay elevated and no major disruptions in job markets are foreseen. Calgary should continue to attract a significant number of workers, albeit less than in previous years. The metro area has experienced the second largest population growth in the country between the last two censuses of 2001 and 2006, but the net inflow of migrants may have already peaked. Employment prospects have also improved in other provinces. Nonetheless, abundant job opportunities and strong wage growth should continue to support a high demand for housing into next year. If Calgary’s housing market can pull off a much sought after soft-landing, which we think it can, this would bode well for Edmonton whose housing market cycle isn’t far behind.

Edmonton – Not far behind

Edmonton’s home price appreciation curve is just a half-step behind that of Calgary’s. Indeed, whereas price growth for both new and existing homes in Calgary has been cooling since the fall of 2006, the same started to occur in 2007 for Edmonton.

Furthermore, as was the case for Calgary in 2006, single-detached unit starts, completions and absorptions have accelerated in 2007. Meanwhile, the existing home market continues to set new benchmarks for sales and average resale price. Led by the condo market, the year-to-date unit sales gain is close to 15%. Yet, listings have shot up in excess of 60% over the same period last year. The consequent reduction in the sales-to-new-listings ratio should translate into softer price growth in 2008. By then, past and current erosions in affordability should also be making a dent into sales.

Looking at the existing home market conditions shows that from 2001 to 2003, the flow of new listings was outstripping that of sales. The situation has since then reversed sharply as the supply of existing homes has been unable to keep up with demand. The latter development has pushed market conditions in Edmonton’s housing market squarely into seller territory. As for the new home market, housing starts and completions have been playing catch-up to a surge in demand for new homes. Housing starts are expected to be in an elevated range of 15,000-16,000 units range for the forecast period.

Last year, for the first time in eight years, housing completions in Edmonton had finally managed to more than match sales of new homes. Our measures of market conditions show considerable relative demand pressures, i.e. a strong ‘seller’ market.

Even less so than in Calgary, therefore, we don’t expect Edmonton to return to a balanced market in 2008. While sales are expected to soften on the back of eroding affordability, the outlook for continued robust oil-sands investment and solid job growth of 3% will provide a strong underpinning for housing demand. As such, look for Edmonton to record the fastest gain in prices among the major markets for the second year in a row in 2008.

Winnipeg looks the other way

Among the metro markets covered in this report, Winnipeg stands alone as one where new housing market activity is both high and trending up. Even if more existing home listings have come on tap to help quench demand built up in the last 3 years, a look at the housing market statistics shows that new home sales have not been met by a sufficient number of completions. Winnipeg exhibits, along with Edmonton, the strongest relative demand pressures out of the 7 major metro markets analyzed. Some of the increased demand of late can be traced to a steady pickup in year-over-year population growth. After decelerating since mid-2004, population growth has climbed back to 0.7% annualized year-to-date, towards the 1% average of 2003-05.

Total housing starts have tried to keep up, and should reach a 19-year high level upwards of 3,000 units this year. This will mark a seventh consecutive year where housing starts have increased. Driving the gains are new starts in multi-family units; semi-detached, row, and apartment units. Single-detached units are also being built at an increased pace, leading to a moderate build-up of inventories in recent months. In view of this year’s run-up in housing starts and stocks -- together with prospects for a tapering off in demand -- look for homebuilding activity to slow a notch in 2008.

Certainly, the average yearly growth of 7% in the number of listings in 2003-06 has kept resale home price growth in check. Nonetheless, Winnipeg is the only major metro market to record double-digit resale home price growth every single year since 2003. We predict that streak will be broken in 2008. However, Winnipeg will still flirt with 10% price growth, as both the upside and the downside appear limited for this market. Affordability has eroded somewhat but remains quite good, especially in comparison with other markets.

The average resale price of a home in Winnipeg stood at roughly half the Canadian average in 2003. Extrapolating 10% price growth would only have it break the $200,000 mark towards the end of 2009, which would then stand at still 40% less than the expected Canadian average. That gap should narrow however. Overall market conditions clearly highlight the tightness of the market and suggest that the Winnipeg housing market will not reach balanced conditions within the forecast horizon. And for those who are keeping track, this means that Winnipeg’s streak of outperforming Canada as a whole in terms of resale home price gains should continue heading into 2009.

Toronto – In cruise control

Canada’s largest metro housing market is experiencing a well-behaved soft landing. Housing starts and new home sales should continue to edge down gradually, as they have been since 2003. First-time homebuyers increasingly are looking to the more affordable condo segment, and new condo apartment sales for 2007 should near the record-breaking level of the past two years. Furthermore, more existing homes listed for sale has opened up resale market opportunities and meant a diminished need for new single units. Demand for newly-built condos has remained robust in 2007, with the share of multiples accouting for 2 out of 3 starts.

Studying the underlying economic conditions, we note that even if Ontario isn’t Canada’s job creation engine to the same scale as it once was, Toronto’s metro area continues to drive the province forward, usually faring better than the province as a whole. Its labour market is tight, as evidenced by a generational low unemployment rate, especially in service-producing industries. Wage and employment growth will probably continue to perform on par with Canadian averages, and the moderate pace of home price growth will also help contain potential erosions in home affordability. Furthermore, Toronto continues to attract the largest share of international immigrants into Canada, and the outflow of workers to western Canada is expected to ease as western economies come back down to earth.

As a result of solid demand, the existing home market has tightened this year as sales have outpaced listings. Home prices typically adjust to reflect market conditions with a lag, and this suggests an uptick in resale home price growth for 2008, which we expect to be close to 6%. Overall, Toronto’s market conditions should continue to be balanced. As a testament to this balance, notice that resale home price growth has held in a reasonable 3-10% band throughout the last decade. Steady as she goes, then, for Canada’s largest housing market, which, looking around to other housing markets these days, is a rather enviable prospect.

No slack in Ottawa

Continuing our trek eastward, we find that the nation’s capital housing starts have surprised on the upside. Up by almost 8% year-to-date, they will likely be lower in the second half of this year. As in many other markets, multiple units are largely responsible for the overall increase in starts. Meanwhile, the resale market remains strong, with home affordability still decent but price gains that outpace inflation. Here again, a relatively better affordability for condos has translated into a tighter market and larger price gains for that segment, and vice-versa for single-detached homes.

Better affordability across the river in Gatineau continues to result in a number of workers attached to Ottawa choosing to reside in Québec, which dampens Ottawa’s local housing demand. As the net difference – prices and taxes considered – between the two markets narrows, this trend is likely to abate but could last a while longer as such adjustments take a fair bit of time.

After cooling since 2002, our forecast still suggests a slight pickup in home price appreciation, mostly driven by the recent pace of sales versus that of listings. Following the vigorous job creation year that was 2006, employment is expected to decline by close to 2% this year before picking back up in 2008. Even if public sector employment prospects remain limited, private sector job creation is likely to improve in 2008.

Montréal keeps humming along

Most indicators for the Montréal housing market are pointing up this year. Higher-than-anticipated demand has meant that sales were very strong to start out the year and are showing a double-digit increase over 2006. Even if quality, age, and size of units are at play, a widening price gap between new and existing homes continues to favor demand for the latter, priced 23% lower on average.

More than any other major metro market except Vancouver, the Montréal market will also continue to exhibit the increasing popularity of the condo market. Whereas the single-detached and plex markets lean towards seller market conditions, the condo segment of the market is more balanced. This segment is therefore expected to continue to outperform other segments as far as starts, sales and listings go, but to under-perform in terms of price growth.

The pace of home sales is likely to cool next year, which should help rebalance the market. Under current growth trends in the North and South crown, and given the strength in conversions of older buildings into new condo units on the Island, the underlying supply of new and existing units is keeping pace with modest job and income growth in the region. Relatively good affordability, historically low unemployment rates, and population growth will continue to support a healthy demand. We expect home price appreciation to clock in around 6%, averaging, by a small margin, the strongest performance over 2007-08 amongst major eastern markets.

Pascal Gauthier, Economist
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