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Eroding Affordability: A Canadian Pattern

Written by Posted On Tuesday, 25 November 2003 00:00

As 2003 rolls to a strong real estate close, Canadian financial forecasters predict affordability will decline in 2004.

Canadian housing markets staged an impressive rally in the third quarter inspired by solid affordability rates, according to the latest Housing Affordability Index released recently by Royal Bank of Canada (RBC) Economics . Existing home sales are now on track for yet another record high while housing starts are expected to reach their best level since 1989.

RBC's Housing Affordability Index -- which measures the proportion of pre-tax household income needed to cover the costs of owning a home -- rose just slightly to 31.8 per cent in the third quarter of 2003 from 31.3 per cent in the previous quarter. This translates into $1,260 in average monthly ownership costs in Canada, with financing rates based on the average posted five-year mortgage rate.

"Going forward, we will continue to see a mild erosion in affordability since bond yields which influence five-year mortgage rates are expected to rise," said Carl Gomez, RBC economist. "As it is unlikely that the Bank of Canada will lift its overnight rate any time soon, shorter term mortgage rates should remain a relatively supportive influence on housing markets for most of next year."

The Housing Affordability Index, which RBC has compiled since 1985, is based on the costs of owning a detached bungalow, which they consider a typical target home for first-time buyers. The higher the index, the more difficult it is to afford a house. For example, an Affordability Index of 50 per cent means that home ownership costs, including mortgage payments, utilities and property taxes, take up 50 per cent of a typical household's pre-tax income. Traditionally, shelter costs were considered affordable at about 30 per cent of gross family income.

The Atlantic region remains the most affordable in Canada with an Affordability Index of 26.3 per cent, a mild drop from 26.1 per cent in the previous quarter, which translates into a monthly payment of $914 -- 1.3 per cent higher than the period before -- and an average price of $132,632 for an average detached bungalow. Relatively low mortgage rates and corresponding strength in affordability should keep Atlantic housing demand healthy in the months ahead.

Other than Alberta where the Affordability Index improved slightly to 27.3 per cent from 27.6 per cent in the previous quarter of 2003, affordability declined across Canada according to the RBC report on the second quarter of 2003:

  • Quebec: Affordability eroded in the third quarter, due to sharply higher home prices and a slight increase in mortgage rates. Quebec's affordability index increased to 29.6 per cent from 29.1 per cent in the second quarter, with Montreal’s Index at 29.7 per cent translating into an average monthly payment of $1,094 or, 2.6 per cent higher than the previous quarter. Tight market conditions should ease as the recent boom in new residential construction gives prospective buyers more choices by next year.

  • Ontario: A slight rise in mortgage rates along with a steady but less sharp increase in home prices was enough to erode affordability in Ontario. The province's Affordability Index rose to 31 per cent in the third quarter from 30.4 per cent the previous quarter, while Toronto’s Index was 38 per cent. However, housing market conditions in Ontario are becoming more balanced and pricing pressure is beginning to show signs of easing. Overall sales volumes and housing starts should remain at healthy levels in 2004.

  • Manitoba: An inventory crunch continues to impact affordability in Manitoba, where the Index rose to 30.1 per cent in the third quarter from 29.5 in the previous quarter. Tight market conditions along with sharply rising prices and higher borrowing costs threaten to further erode affordability in Manitoba.

  • Saskatchewan: A sharp rise in prices along with slightly higher longer-term mortgage rates mildly eroded affordability as the Index rose to 29.3 per cent from 29 per cent in the previous quarter.

  • British Columbia: The sharp rise in housing prices and the slight increases in longer-term mortgage rates resulted in the strongest erosion of affordability in Canada, with a peak in Vancouver (Index at 45.3 per cent) with a benchmark price of $320,637 for a detached bungalow. BC's Affordability Index deteriorated to 42.2 per cent from 41.2 per cent in the previous quarter, which translates into a monthly payment of $1,604 for an average detached bungalow (principal, interest, tax and utilities).Weakening affordability failed to deter demand. A deep pool of pent-up demand and supply constraints should continue to put strong upward pressure on prices in the months ahead. Eroding affordability will be a key constraint on domestic BC home buyers over the long term, especially as shortages of trades people and higher land development costs in some urban areas present additional challenges for constructing reasonably-priced new developments. BC housing markets will continue to retain considerable interest from out-of-province investors and buyers.
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