With national home prices up 31.6% year-over-year in March 2021, we often see people discussing how this is not sustainable (and rightfully so). So what would be a healthy and sustainable growth rate?
CREA's national benchmark home price increased from $245,400 in January 2005 to $715,300 in March 2021, seeing a compound annual growth rate (CAGR) of approximately 7.3%. Using data from Statistics Canada, we calculated an approximate annual growth rate in median income of less than 3%, from 2005 to 2019. Just looking at these two growth rates alone, we can conclude that at some point there would inevitably be a large disparity between home prices and income. We can see clearly see home prices grow apart from income in our Real Estate Analytics Dashboard. So has the growth rate we've seen over the past fifteen years been sustainable? We think most would agree that the answer is no, given how many people have been completely priced out of the market in the past decade. National Bank of Canada's Housing Affordability Monitor states that there has never been a worse time to accumulate the minimum down payment. The current price point impacts what a sustainable level of growth going forward would be. If there is agreement that current prices are too unaffordable, then how can we justify that any further growth before wages catch up is sustainable?
It seems that RE/MAX would disagree with us on the topic of sustainable home price growth. Below is a screenshot from one of their recent articles:
We were very disappointed to see this, as the statement that price-growth in the high single-digits is healthy and sustainable is outright false. Even at just 7% annual growth, the national benchmark home price would rise to $1.3 million in 2030 and $5.1 million in 2050. As we discussed earlier, income has not been growing anywhere near this rate and there is no reason to believe that will change. Per Statistics Canada, the median income for individuals aged 25 to 54 years was $48,200 in 2019. Assuming an annual growth rate of 3%, median income would rise to $67,000 in 2030 and $121,000 in 2050. As of March 2021, the national benchmark home price was 14.8x the 2019 median individual income. This home price to income ratio would grow to approximately 19.5x in 2030 and 42.3x in 2050. And remember, we only used a 7% growth rate in our calculations and RE/MAX suggests growth in the high-single digits. Just for fun, we also did the 2050 calculations at a 9% growth rate, resulting in a price of $8.7 million and approximately 72.4x median income. Hmm, not so healthy and sustainable.
Entrepreneur and author Jeff Booth has asked the following question to thousands of people: If I could fold a piece of paper on itself fifty times, how thick would the piece of paper be on fold fifty? The typical response is about two inches with the rare answer of to the ceiling. The answer is 149 million kilometers, or the distance from the Earth to the sun. The purpose of this exercise is to demonstrate that it is difficult to conceptualize exponential growth. Although a company like RE/MAX would know better, an annual growth rate of 7-9% probably sounds pretty reasonable to most people before they go and crunch the numbers - especially since this is what Canada has become used to experiencing.
RE/MAX is the leading real estate organization in Canada and their articles reach many people across the country. Statements like this are irresponsible, creating FOMO and driving an unrealistic narrative of what sustainable growth is. Let’s look at this from one more angle and consider the wealth that this would bring to a homeowner. The minimum down payment on the $715,300 March 2021 national benchmark price home would be $46,500. If that home increased by 7% ($50,100) over the next year, a buyer would effectively earn a 107.6% return (less transaction costs) on their down payment in a single year. Of course the buyer would be making monthly mortgage payments, but this can be ignored as they would otherwise be paying rent costs if it is their home that they live in, or they could cover a large portion of those payments with rental income if it is an investment property. When we compare this kind of (sometimes tax-free) return to the median income in this country, is this a reasonable gain simply for owning a home?
We'll stop knocking RE/MAX now and take a look at the stance on sustainable price growth from other key parties:
The Bank of Canada’s mandate targets a 2% inflation rate but does not consider home prices and concerns have been raised regarding the methodology of accounting for shelter costs in the Consumer Price Index (CPI). The Bank of Canada implements measures to ensure their inflation target is achieved, which are partially responsible for rising home prices. These include lowering interest rates and recently, introducing quantitative easing.
CMHC, whose mandate is to make housing affordable for everyone in Canada, does not publicly set a target home price growth rate, nor does it have the tools to influence this on their own. Without defining and working towards a measurable target, the goal of affordable housing can quickly slip away.
The top of the federal government has mostly been silent on the growing housing affordability. It is largely recognized that the measures introduced in the latest federal budget will not have any significant impact on the housing market. MP Adam Vaughan infamously suggested that although home prices grew over 30% in the past year, even a 10% decline in home prices would not be acceptable.
It is clear that no one is taking responsibility for the unsustainable price growth we have seen recently. All levels of government, CMHC, and the Bank of Canada are making decisions that impact housing prices, directly or indirectly. Yet with no formal guidance on sustainable growth or regularly monitoring against such a benchmark, it is easy for things to fall out of balance. While New Zealand has their own problems with high home prices, they recently announced that their central bank must now consider the impact that their monetary and financial policies have on housing prices.
Although it is easy to look at historical prices and say "Canadian real estate only goes up" - the saying that past performance is not indicative of future results is very applicable here. Interest rates have been falling for the past 40 years, which has contributed significantly to the rising home prices. New buyers won't get this same benefit going forward as interest rates are already next to zero, and we might not see anywhere near the same price appreciation that Canadians have gotten used to. That being said, if policymakers want to keep the party going, they could make policy changes to increase borrowing ability (and home prices) such as extending the maximum allowable amortization term. There is also the risk of currency devaluation, a topic of increasing concern as money supply grows and Canada continues taking on more debt. The fact that the rules could continue being changed to support high prices is exactly we need to better define a sustainable level of home price growth and ask policymakers across the board to consider the impacts that their decisions have on home prices.
The idea of sustainable growth depends on the assumption that as a society, we want current and future generations to have the opportunity to buy a home based on their earned income and not just their inheritances. If that is not a priority, then this conversation about sustainable home price growth doesn't really matter. If it is a priority, then we need to reset our expectations when it comes to sustainable home price growth, and Canada should consider following New Zealand’s lead.