What Is A Housing Bubble? And Are We In One?

What is a Housing Bubble?

A housing bubble happens when the price of homes rises quickly, at an unsustainable rate. Typically, a price-growth rate that’s in the high single-digits is considered to be healthy and sustainable. Under healthy conditions, homeowners continue to earn equity over time, sellers can make a profit on resale, and buyers can still afford to get into the market. This type of price growth can usually be explained by economic factors, such as an employment boom and favourable interest rates.

On the other hand, a housing bubble can happen as a result of non-organic growth. For example, if speculators were flooding the market, buying up homes to take advantage of rapid price growth, with the intention of selling in the near term for a hefty profit. When prices are deemed to have hit a high point, speculators list their properties for sale. This massive influx of listings, coupled with stagnating demand, causes prices to plummet and results in a “housing market crash.”

A housing bubble is a temporary event and prices eventually return to normal levels, when demand rises again and home-buying activity resumes.

What Happens When a Housing Bubble Bursts?

During a housing bubble, homes become overvalued. When the bubble bursts, prices fall. Homeowners who have no intention of selling are unlikely to feel the direct impacts of the bursting bubble. However, these market conditions often indirectly impact other aspects of the economy, so to call homeowners who aren’t selling “free and clear” would be misleading. The ripple effects of a bursting housing bubble would likely touch most of us, in one way or another.

Homebuyers who purchased a home during a housing bubble likely paid considerably more than it is worth. Properties bought by end-users as a residence, with no intention of being sold in the short-term, will eventually rebound closer to “normal” values and at some point, return to positive growth.

A housing bubble poses the biggest risk to sellers who purchased at the peak of the market, and now find themselves forced to sell their home amidst a deflating bubble. If prices have declined enough, the seller could potentially see offers that are below what they paid for the home, and potentially below what they owe on their mortgage. In this scenario, the seller still owes money to their mortgage lender on a home that they no longer own.

Are We in a Housing Bubble?

The Canadian housing market took a surprising upward turn during the COVID-19 pandemic, after coming to a grinding halt in mid-March 2020. The slow-down was short-lived, and what followed through the remainder of 2020 or in 2021 was a a spike in demand for homes met by a shortage of supply. With 2022 well underway, we are finally starting to see softening market conditions. Are the effects of the Bank of Canada’s (BoC) tightening cycle being felt in the Canadian real estate market?

The May data from the Canadian Real Estate Association show national home sales were down 8.6 per cent month-over-month and down 21.7 per cent year-over-year, compared to the record high reached in May 2021. However, it’s interesting to note that May 2022 sales were largely in line with the 10-year average for this time of year.

What about prices? The MLS® Home Price Index (HPI) declined 0.8 per cent month-over-month but was still up 19.8 per cent year-over-year. The actual (not seasonally adjusted) national average sale price rose 3.4 per cent year-over-year.

“May picked up where April left off, with sales activity continuing to slow and softening prices in many parts of the country,” said Jill Oudil, Chair of CREA. “Inventories are finally beginning to rebuild from record lows just a few months ago, although we still have major supply shortages almost everywhere. With all that being said, we are in a period of rapid change, but one that should settle to a more balanced housing market in time. As conditions continue to evolve, contact your local REALTOR® for information and the guidance you will need buying or selling in this current environment,” continued Oudil.

“Ultimately this has been expected and forecast for some time – a slowdown to more normal levels of sales activity and a flattening out of prices,” explained Shaun Cathcart, CREA’s Senior Economist. “What is surprising is how fast we got here. With the now very steep expected pace of Bank of Canada rate hikes, and fixed mortgage rates getting way out in front of those, instead of playing out steadily over two years, that cooling off of sales and prices seems to have mostly played out over the last two months.”

For a housing bubble to burst, there needs to be a steep incline in inventory and new listings, and a decline in demand. While the demand side of the equation seems to have eased from the frenzy that was 2021, supply levels are still far from the flood needed to pull the Canadian real estate market into a tailspin.

The number of new listings in Canada rose 4.5 per cent month-over-month in May, largely influenced by a spike in new supply hitting the Montreal housing market, while new listings in the Greater Toronto Area saw a small decline. The shift between sales and new listings prompted the sales-to-new listings ratio back to 57.5 per cent – the lowest level since April 2019 and near the long-term average of 55.1 per cent.

CREA points out that in May, “almost three-quarters of local markets were balanced markets based on the sales-to-new listings ratio being between one standard deviation above or below the long-term average in May 2022 – the largest number since the fall of 2019. A little less than one quarter were in seller’s market territory, while a small handful were in buyer’s market territory.”

May had 2.7 months of inventory, about one month more than what was available on the market in April. This measures the number of months it would take to liquidate all available housing inventory at the present rate of sales. While improving, this is still historically low. The long-term overage for this time of year in five months, CREA notes.

Housing Crash 2022?

Will the Canadian housing market crash in 2022? Will the housing bubble burst? It’s been rumoured and speculated upon for the last decade. Only time will tell what lies ahead, but the recent spike in prices, high levels of household debt and looming interest rate increases could cause further softening in the market. But that does not mean the market will crash. Some industry insiders argue that prices have risen so much recently that there’s room for them to ease without triggering a crash, and this could be welcome news for young homebuyers trying to get their foot in the door. On the other hand, with no housing supply boom expected and immigration numbers continuing to grow thanks to the federal government’s 2022-2024 Immigration Levels Plan, there could be enough demand to absorb any new supply, staving off the flood of listings that would prompt a market crash.

Homebuyers and Sellers, Do Your Due Diligence

Challenging market conditions and a still-present global pandemic have added some personal risk on the part of homebuyers and sellers. It’s important to remember that market conditions vary across Canada, and can be dramatically different between provinces, cities, and even from one neighbourhood to the next. Now more than ever, it’s important to work with a trusted, experienced professional Realtor who can guide you though the buying and selling process.

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