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January 30, 2012 10:27 ET

Canadian Housing Market a Balloon Not a Bubble-BMO's Sherry Cooper Releases Special Report

- Moderate activity, stable prices anticipated through 2013

- Low interest rates should hold affordability in check allowing household income to catch up with prices

- Currently strong sales in Alberta, Saskatchewan, Newfoundland & Labrador, as well as in Toronto, Montreal, Winnipeg, Halifax and Ottawa

- Previously red-hot Vancouver softening

- BMO advises homeowners to choose a 25 year amortization

TORONTO, ONTARIO--(Marketwire - Jan. 30, 2012) - The housing boom in Canada is more likely to cool than correct, according to a new special report released today by BMO's Economics Department.

"With the exception of a few regions, valuations remain only moderately high across the country, especially when low interest rates, demographics, construction costs, land-use regulations and foreign capital inflows are considered," said Sherry Cooper, Chief Economist, BMO Financial Group. "Low interest rates should hold affordability in check for some time, allowing incomes to catch up with higher prices and restore proper valuations."

Balloon, not a bubble

According to the report, elevated valuations do imply the risk of a material correction in the event of a shock, such as a spike in interest rates, a severe recession or stalled foreign investment. "Barring one of these triggers, however, a dramatic correction is unlikely," suggested Dr. Cooper. "In our view, the national housing market is more like a balloon than a bubble. While bubbles always burst, a balloon often deflates slowly in the absence of a 'pin'. In most regions, where valuations are just moderately high, the air should seep out slowly, as rising incomes catch up with higher prices, allowing valuations to normalize before interest rates do."

Dr. Cooper added that while household debt in Canada has been a point of concern, debt levels relative to income are not as troublesome as some suggest and likely will not trigger a severe market correction. "Contrary to some reports, Canadians have nowhere near the debt burden of Americans at the peak of the housing bubble. Even today, after four years of U.S. deleveraging, household debt ratios are lower in Canada."

Cost of housing not out of reach

Dr. Cooper noted that on a national basis, the cost of housing is not out of reach for the typical buyer. "Because of low mortgage rates, the typical homebuyer still spends just over one-third of disposable income on mortgage payments, a share that's just modestly above long-term norms."

She added that interest rates won't stay low forever, and even a moderate two-percentage point increase to more normal levels would put some strain on affordability and slow the market. However, for current owners, moderate rate increases likely won't severely stress affordability given that about 68 per cent of mortgages have fixed terms - many five years or longer - and most variable-rate holders will likely lock-in when rates begin to climb.

Katie Archdekin, Head of Mortgage Products, BMO Bank of Montreal, warned that even in a low interest rate environment, Canadians should prepare ahead of time financially in case of future increases.

"Regardless of current interest rates, it is important for homeowners or potential buyers to be prudent and stress-test their mortgage against a higher interest rate to ensure they can afford what they signed up for. The rule of thumb is total housing expenses should not consume more than one-third of total household income." Ms. Archdekin added that Canadians looking to buy a home should consider a maximum amortization of 25 years, which will save homeowners thousands of dollars in interest rates over the life of the mortgage and ensure Canadians can become debt-free faster.

Other national and regional findings include:

  • Home ownership in Canada at record highs, climbing about four percentage points in the past decade to around 70 per cent, which is above the current U.S. rate of 66.3 per cent and even above the peak U.S. rate of 69.2 per cent.
  • The national housing boom has already cooled, with Canadian home sales up just 4.6 per cent in 2011 and the once red-hot Vancouver market softening. Sales have declined considerably in Vancouver and remain soft across British Columbia.
  • Sales remain strong in Alberta and Saskatchewan as a result of healthy rates of immigration from other countries and provinces, as well as solid investment-led economic growth. Alberta is enjoying the fastest private-sector job creation in three decades.
  • Demand remains robust in a few major centres outside of these three provinces, notably Toronto, Montreal, Winnipeg, Halifax and Ottawa.

The complete report can be downloaded at www.bmocm.com/economics.

For more information on BMO's home financing solutions, please visit www.bmo.com/mortgages.

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