Rising house prices are causing heightened concern, both because of declining affordability and the impact of a housing price bust.
Average house prices have increased by at least 25 per cent in Toronto over last year – where the average price for a detached house now tops $1.2 million. Over the past 12 years, average house prices across Canada have more than doubled, far outstripping wage and income growth.
There have been many warnings of an impending real estate bust in Canada over the past decade. But prices have continued to rise as borrowing rates declined. If mortgage rates finally rise, a drop in house prices could quickly follow.
This would affect the economy in several ways:
- a decline in construction and real estate activity;
- a drop in consumer spending;
- increased bankruptcies; and
- lower revenues from taxes, and lower government spending.
A drop in construction activity to its historical average would mean about 250,000 fewer jobs and 1.8 per cent lower Gross Domestic Product (GDP). An average house price drop of 20 per cent would wipe out about $700 billion of Canadian household real estate wealth. This alone could lead to about $40 billion less in consumer spending, through the “wealth effect,” as households can’t use their homes to finance ongoing consumption. This would be equivalent to reducing Canada’s economic growth by about two per cent – enough to drag us into a recession.
The stakes are high, which is why the Bank of Canada has been so reluctant to raise interest rates, even though low rates have fueled ever-higher house prices. Governments are finally taking some steps to contain house price increases, like more funding for affordable housing and taxes on foreign buyers to reduce speculation. But there’s little attention on the fact that we need a more sustainable driver of economic growth than low interest rates and rising asset prices – and that must come from higher wages and rising household incomes.