Canada’s largest bank believes real estate affordability will continue to deteriorate. RBC Economics updated their Affordability Index for Q3 2018. The index, which shows how much a household would pay for a mortgage, printed one of the worst levels in history. Analysts from the bank expect affordability to get worse in 2019, as interest rates rise. However, they did mention the decline in affordability will be mitigated by falling prices.
RBC Affordability Index
The RBC Affordability Index is one of the many indexes that compare how much it costs to own a home. The index presents the ratio of income median households need to use to buy a house today. They use a five year fixed rate, assuming a 25 year amortization, and a 25% down payment. There’s a few notes you should also remember that help us understand why this data is useful.
A lot of people look at this number and think, “OMG – Canadians are paying how much of their income?!” No, the vast majority of Canadians bought before the spike in prices. This means the lion’s share of households are minimally impacted by a rise in servicing costs. Heck, most banks wouldn’t lend someone the money if they needed to spend more than 50% of their income on debt service.
Instead, the takeaway is in regards to liquidity. The higher the servicing costs, the smaller the pool of qualified buyers. Illiquid assets tend to experience wild swings in prices, not all positive. This is actually pretty obvious if you look at the index. The peaks aren’t elevated for more than 3 years, without a correction and recession.
Canadian Real Estate Is The Least Affordable Since 1990
The affordability index for Canadian real estate held its level for a second quarter. A median household in Canada needed 53.9% of their income in Q3 2018, the same as the previous quarter. That number represents a 3.05% increase compared to the same quarter last year. While high, we’re still under the peak level of unaffordability established in Q2 1990.
Canadian Real Estate Affordability (RBC Index)
The percent of income required by a median household to service mortgage debt on a conventional mortgage across Canada.
Source: RBC Economics, Better Dwelling.
RBC Economics noted that rising interest rates are to blame. Interest rate increases accounted for the full increase over the past 5 quarters. They further mention the “outlook isn’t promising,” with higher rates expected in 2019. However, falling prices will help mitigate some of the rise in rates.
Toronto Real Estate Costs Over 75% of The Median Income
Toronto real estate became slightly more affordable in the past quarter. The affordability index for Toronto fell to 75.3% in Q3 2018, down 0.79% from the previous quarter. Compared to the same quarter last year, the market is 0.13% more affordable. The peak for unaffordability for the Toronto real estate market was hit in Q2 2018.
Toronto Real Estate Affordability (RBC Index)
The percent of income required by a median household to service mortgage debt on a conventional mortgage across Greater Toronto.
Source: RBC Economics, Better Dwelling.
Vancouver Real Estate Requires Over 86% of Income
Vancouver real estate is slightly more affordable, but still in deep “crisis” territory. The affordability index fell to 86.9% in Q3 2018, down 1.69% from last year. The quarter-over-quarter change improved, but the index is still 3.2% higher than last year. Peak unaffordability was hit in Q2 2018, with improvements attributed to a fall in prices.
Vancouver Real Estate Affordability (RBC Index)
The percent of income required by a median household to service mortgage debt on a conventional mortgage across Greater Vancouver.
Source: RBC Economics, Better Dwelling.
RBC Economics further added that affordability will continue to deteriorate. As rates rise, so will the cost of paying for a home, although they acknowledge lower prices will help. They fail to focus on the fact that spikes to the index usually only last a few years, before regressing to the mean. Ah well, it probably just slipped their minds.
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That’s the problem with bank shills. They produce a chart, then come to the conclusion that whatever is most profitable will c continue to happen, regardless of whether or not the historical patterns in the chart make sense.
Affordability…humm, we did not have Toronto LTT in 1990. Keeps a lot of folks from upsizing and downsizing. Many people refuse to give up such large sums. I always felt it was backwards, the seller should pay not the buyer. The seller is the one wish big cash in hand. Makes no sense until you see the politics behind it. Whom benefits most from this arrangement? Seniors. Young families, the city has no interest in meeting their needs. None.
Super important data.
RBC and NB affordability metrics are among the best measures of overvaluation in my view.
If you analyze that data correctly it will also give you a hint of how much prices are expected to fall.
Care to elaborate Xelan? What do you see as the percentage decrease from here? (I’m in Toronto) Are you basing that on trend lines? With a quick glance it seems like 40% is about average.
Also, is this gross or net income? I may have missed it.
Yes, you approach is correct, you find average and that’s the value historically considered as fair affordability.
Just remember that affordability depends on 3 things: wages, prices and lending standards. Changes in all those 3 components affect affordability.
Since wages are unlikely to spike affordability will be brought back to normal either with price declines or lending standards changes or both.
RBC is using gross income.
Thank you for pointing out the obvious Captain. This article should have been written in 2015….
It’s a quarterly report. Classic case of Dunning-Kruger, high sense of entitlement, due to a low sense of intelligence.
@Xelan_gta, what do you think for how much prices will fall?