July 15, 2012 / 9:14 PM / 6 years ago

Analysis: A cooling Canadian housing market still poses risks

TORONTO (Reuters) - For the first time in three years, Toronto’s sizzling housing market is showing signs of cooling, bringing a sigh of relief to David Fleming and other Canadian real estate agents who feared the market boom was getting out of control.

Buildings are constructed in Toronto December 15, 2009. REUTERS/Mike Cassese

“It is a balanced market right now, where you don’t have to make a decision with a gun to your head,” said Fleming. He said the bidding wars of the past few years have evolved into mere skirmishes among prospective buyers.

But it may be too soon to sound the all-clear, some experts warn. What appears to be a gentle retreat right now could yet turn into a bruising rout.

A tightening of government-mandated mortgage rules that came into effect last week could begin a tipping point, keeping enough would-be buyers out of the market to trigger a freefall in prices, especially at the low end.

For the time being at least, most economists and realtors believe the soft landing that policymakers have sought to engineer is starting to take shape. The slowdown comes after a robust, three-year climb in Canadian home prices and booming construction of condominiums.

“The housing market is already slowing down and that’s something that we know looking at numbers, sales activity and even prices,” said Benjamin Tal, senior economist at CIBC World Markets.

“The recent change to regulations is really a gentle push in an already slowing market. And you always run the risk, when you push something that is already slowing, that you might make it fall,” Tal said.

Mindful of the U.S. housing boom and bust that still plagues their southern neighbors, Canadians have taken up a collective gnashing of teeth over surging home prices and the correction they fear is right around the corner.

Canada, which does not have a significant subprime mortgage market, did not experience the housing market crash that drove the United States and other Western countries into recession. While the Canadian market did retreat in 2008, it rebounded swiftly on the back of the low interest rates that have continued to drive activity.

But with signs of slowing already popping up around the country, experts are debating whether the recent tightening of mortgage lending rules is just enough — or too much — of a good thing.

Sales of existing homes in Canada slowed 3.1 percent in May from April and prices declined from the year before, only the second drop in average prices in the past year and a half, data from the Canadian Real Estate Association showed last month.

Figures released this week showed the average price of a detached bungalow rose 5.5 percent in the second quarter from a year earlier, while the average condo price was up 3.3 percent year over year. While still far from a slump, the price increases are down from 7.5 percent and 3.5 percent, respectively, in 2011.

Tal said he believes prices could fall by 10 percent to 15 percent in the next 12 to 24 months, cooling the market just in time for expected interest rate increases in 2013 or 2014.

“I think that’s the most likely scenario and probably the best scenario. Any softening we get now before the eventual increase in interest rates is a bonus,” he said.

But realty group Royal LePage, which compiled the quarterly price data, said the market is at a tipping point and the government’s move to limit borrowing was a mistake.

“The cumulative impact of these new regulations has created a significantly higher hurdle for young buyers seeking their first home and comes at a time when the market was slowing of its own accord. The timing of this intervention was unfortunate,” said Phil Soper, president and CEO of Royal LePage.

The new rules introduced by Finance Minister Jim Flaherty make it harder for homebuyers and homeowners to take on massive debt, the government’s fourth attempt in four years to put the brakes on a housing boom. The changes took effect July 9.

Canadian policymakers want tighter mortgage rules to do the work that interest rates cannot, given the inability or unwillingness of central banks to raise borrowing costs in the face of global economic problems.

The mortgage rule changes cut the maximum length for government-insured mortgages to 25 years from 30 years — shorter than the standard 30-year mortgage in the United States — and lower the maximum amount Canadians can borrow against their homes to 80 percent from 85 percent, among other measures.

The shorter mortgage length is the equivalent to raising borrowing costs for first-time homebuyers by 1 percent, Tal said. The move effectively lowered the budgets of many house hunters, particularly those at the low end of the market who cannot put enough money down to avoid mortgage insurance.

Jonathan Basile, director of economics at Credit Suisse in New York, said he thinks the tighter borrowing rules were the right approach, given the unsustainable pace of the market.

“Tightening mortgage rules is not like shutting off the spigot — you’re just cutting off some of the flow,” he said.

Basile predicts a housing correction through the end of the year, a cooling that is likely to be orderly, but not without some risks of scary gyrations.

“Corrections don’t happen in a straight line, they can get a little dicey. So it doesn’t mean it is going to be a smooth transition with no bumps,” he said.

Real estate agent Fleming said Toronto house hunters should just be grateful for the respite in rising prices in what, 2008 aside, has been a 19-year bull market.

“Buyers should also take this and run with it. They’ve got an opportunity to be able to choose and not have to bid against seven other people,” Fleming said. “It’s not a full buyer’s market, but it’s the closest thing we’ve seen in a long time.”

Reporting By Andrea Hopkins

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