Canadian real estate prices have been on a tear, with a typical home now making more than the people inside of it. Still, a new model from the Bank of Canada (BoC) thinks that’s not bubbly, and is within their policy. The central bank’s Q1 2021 numbers show only three real estate markets are exuberant. As you may have guessed, Toronto is one of those markets.
Bank of Canada House Price Exuberance Indicator
The Bank of Canada (BoC) recently created a model to detect exuberance in housing markets. It detects explosive movements in home price growth, compared to fundamentals. They then put it into a neat, color-coded chart.
When home prices grow faster than fundamentals, buyers are said to be exuberant. If it becomes common for the whole market, the market is said to be exuberant. An exuberant market is better known as a bubble. The concept is similar to the US Fed’s groundbreaking work on exuberance detection.
The exuberance indicator uses fundamentals based on disposable income, population, and mortgage rates. Disposable income is measured on a per capita basis, and the mortgage rate is the real effective rate. Really wanting a cottage and paying extra for it, isn’t a fundamental. Even if the BoC governor keeps repeating that sentiment, it’s not based on their own research.
The BoC has made it stupid easy to read these indicators. Each rectangle is a quarter, and they’re shaded in one of three colors, which show intensity. Green means the market is rational for the fundamentals. Orange means it’s heating up, with signs of exuberance showing, also known as “froth.” Red means full-on exuberance, a.k.a. a bubble. In the BoC’s own words, this raises “the likelihood of a costly adjustment in the future.”
Toronto and Hamilton Real Estate Get Bubbly Label
Only three markets were exuberant in the most recent quarter, and one of them is Greater Toronto. The region logged a second consecutive quarter of exuberance in Q1 2021. From 2016 to Q1 2021, the market has only seen 7 quarters without exuberance. Two-thirds of the past 5 years of price growth have not been based on fundamentals. With little time between exuberant periods, the market hasn’t had time to correct.
Canadian House Price Exuberance Index
Source: Bank of Canada.
Hamilton real estate has been getting a lot of attention these days, for all of the wrong reasons. The region, located an hour from Toronto, showed exuberance in the most recent quarter. The market has seen the same number of exuberant quarters as Toronto, over the past 5 years. Hamilton’s sudden price growth even got the small city on the radar of the IMF, whose models indicate home prices are about 40% overvalued.
Montreal Real Estate Gets Hit With An Exuberant Label
Montreal real estate is still relatively affordable, but may not be that way for long. In Q1 2021, it finally moved past fundamentals to print its first exuberant quarter. It hasn’t seen this kind of price acceleration detached from fundamentals since 2012. One quarter almost makes it seem like a stable market, doesn’t it?
Greater Vancouver Real Estate Hasn’t Seen Exuberance Since 2018
It may surprise many, but Greater Vancouver real estate hasn’t been exuberant since the 2018 rush. The BoC model shows Q3 2018 was the last quarter where the market was last in this territory. Now that doesn’t mean it’s affordable or priced right for local incomes.
Not showing signs of exuberance just means price growth isn’t unusually strong. In this case, prices are just above where they were 3 years ago, despite recent acceleration. That does bring up a separate question though. How long can a market be detached from local incomes, before it suffers? That’s a different topic for another day.
The BoC sharing data points that show there’s more than just “froth” is a big change. Earlier this year, the central bank was blamed for boosting price growth expectations. Along with the Federal government, this boosted moral hazard. Now they are releasing a steady stream of messages to temper those expectations.
Hawkish policy, tapering QE, and housing exuberance data are three big market messages. The BoC has yet to publicly state the sudden change in attitude towards housing. However, they are certainly leaving a breadcrumb trail for people to conclude that.
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