Sunday, 2 March 2014

According to BMO's Report We Should be in a Housing Bubble

Back in 2005, as the US was in the midst of a housing bubble, the Bank of Montreal published a report examining whether a real estate bubble was taking root in Canada.

In probably one of the most objective reports that I've read by a bank, BMO came to the conclusion that back in 2005 the housing market was not a bubble due to low interest rates.

However it warned that further property appreciation combined with rising rates would move the housing market into bubble territory. Also, BMO noted that Vancouver is most vulnerable to such a scenario.

Since the analysis in the report, home prices in Canada rose by 70%.

Below I present some surprising quotes from the report along with updated graphs.

"The simplest approach to identify a housing price bubble is just to visually inspect recent growth trends to see whether it represents exceptionally strong price gains relative to its historical performance."- BMO 2005

home price growth in canada

"An alternative approach to identifying boom conditions is to ask whether real, or inflation-adjusted, housing prices have started to rise above the peaks achieved in the previous boom of the late 1980s."-BMO 2005

canada home prices adjusted for inflation royal lepage

The red arrows indicate scenarios under 5%, 6%, and 7% five year mortgage rates. How could the housing market be sustainable when it's at the mercy of interest rates? Moreover, even if rates don't rise for the next decade, it does not necessarily mean that the housing bubble in Canada won't burst!

monthly mortgage payments in canada

And, if you account for inflation, real monthly payments as a percentage of median income looks like this:

"The main risk to this outlook is that interest rates, especially long rates, have provided, and will
continue to provide, too much stimulus despite this expected tightening. This could result in housing prices continuing a strong upward trend that move the housing market into ‘bubble’ territory. " - BMO 2005

What I really find fascinating is that today BMO does not see a bubble coming. Here's a recent quote:

“There are doubters and skeptics that say the housing market is not sustainable, but we don’t see a bubble coming,” said BMO senior economist Robert Kavcic.



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