Canadian CEOs don’t think that the country’s real estate market is in a bubble, but that doesn’t mean they’re optimistic about further growth.

A recent Compas Inc. poll shows that business leaders expect a rise in residential real estate prices over the next 12 months of just 1.75%. That’s a modest prediction, given that real estate prices jumped 18% in the past year, and that over the past 20 years, they increased on average by 3.4%.

Like the executives polled, the Canadian Real Estate Association (CREA) expects to see continued growth in housing prices as well as increased buying and selling through the first half of 2010. Both CREA and the poll respondents said many homebuyers are looking to purchase homes before the harmonized sales tax comes into effect. “B.C. and Ontario are likely to see house prices drop in the latter two quarters of this year, following the adoption of the HST,” said one executive.

Rising interest rates are also expected to cool the market. Some of Canada’s big banks have already begun to adjust their historically low rates with recent hikes in the cost of fixed-rate mortgages.

The Canadian housing market tumbled following the international financial crisis in 2008, but it experienced a quick rebound, starting in 2009. In total, Canada’s housing prices have increased by 92% since the beginning of 2000, according to the Teranet-National Bank House Prices Index.

But according to the chief executives, the housing market faces years of slow growth. Two years from now they expect average residential prices to be up by 5% overall. They believe that over the next five years, prices will experience an overall increase of 13.9%.

The executives also weighed in on which major markets will see the strongest prices over the next five years. Respondents expect Vancouver, which saw prices increase by 22% in the last year, to continue to have strong growth. The executives polled also see strong markets in Calgary and Toronto, but expect Ottawa and Montreal to experience the least growth.

Canadians could be facing higher interest rates sooner than previously thought as a result of stubborn inflation and stronger economic growth, Bank of Canada Mark Carney said Wednesday.

Carney did not declare higher rates were on the way, but issued his clearest signal to date that his year-old commitment to keep the policy rate at the record 0.25 per cent until July was "expressly conditional" on inflation remaining tame.

In a speech to a business audience, the bank governor noted that both underlying core inflation and economic growth have grown slightly stronger, although broadly proceeding as expected.
The tip-off to economists was that he changed his language on his conditional commitment on interest rates, which has led to historically low rates for both consumers and businesses in Canada and helped the country recover from recession.

"This commitment is expressly conditional on the outlook for inflation," he told the Ottawa Economic Association.

It was the first time Carney has undercut the commitment in such pointed language.
Later, Carney downplayed the significance, joking with reporters that he needed to used different words to keep the media's attention.

But economists said the distinction was significant.
"They still have considerable latitude, but the changes that would be required to their forecast are consistent with hiking rates sooner than markets are anticipating," said Derek Holt, Scotiabank's vice-president of economics. He said Carney may move as early as June 1.

But Holt stressed that Carney's overall message to Canadians is that rates will remain low by historical standards for some time.
"No matter what, we emerge from this with lower rates at the end point of the hiking campaign than in past cycles. He's saying the outlook is clouded with risks and there's a number of reasons to expect growth to be lower than past cycles."

Core inflation - which excludes volatile items like energy - has been stubbornly sticky the past few months, with the index rising to 2.1 per cent in February. That's the first time it has been above the central bank's target of two per cent in more than a year.

And Carney pointed out that the economy has performed better than he thought when the bank issued its last forecast in January, predicting growth of 2.9 per cent this year. Since then, several private sector economists have increased their projections and Carney is expected to do the same at the next scheduled forecast date on April 22.

At a news conference following his speech, Carney warned against reading in too much optimism in his assessment.
"It wasn't that rosy a message," he said. He cautioned that low U.S. demand and the high Canadian dollar, which was trading below 98 cents US on Wednesday but still high by recent standards, were acting as "significant drags" on the economy.

On a longer term basis, Carney's message to Canadians was positively dark, warning that the country needs to address its "abysmal" productivity record and that the world needs to follow through with reforms to address global imbalances, particularly China's undervalued currency.

Carney calculated that unless the country improves its productivity or output per unit of work, Canadians can expect to lose a total of $30,000 in real income over the next decade.
"Canada does underperform," he said. "We are not as productive as we could be. Our potential growth is slowing. Moreover, this is occurring as the very nature of the global economy ... is under threat."

New home prices in Canada kept climbing in January, rising 0.4 percent from the previous month as expected, according to Statistics Canada on Thursday.

On a monthly basis, the housing-only component of the new housing price index rose by 0.5 percent and the land-only component edged up 0.1 percent.

New home prices firmed 0.1 percent in January from a year earlier, the first year-over-year rise since December 2008.

Despite nationwide gains, prices have been falling in Western Canada, which saw huge price spikes prior to the recent economic crisis.

"Declines slowed in most of Western Canada's metropolitan regions as new housing prices returned to the price levels observed prior to the highs registered at the end of 2007 and the beginning of 2008," Statscan said.

The Canadian housing market slumped during the recession last year but never underwent a U.S.-style collapse. Strong sales and price gains in recent months have led to worries of a made-in-Canada housing bubble and prompted the government to tighten mortgage lending rules in February.

The study also looks at recent events in the United States and that country's mortgage insurance policies. It points out how the American government interfered in the U.S. mortgage market through legislation that encouraged financial institutions to issue mortgages to high-risk groups for social reasons.

It also highlights how the U.S. government signalled an implicit public guarantee against financial failures by directing government sponsored enterprises (GSEs), similar to the CMHC, to buy and securitize mortgages for high-risk borrowers.

"In the wake of the recent financial crisis, American taxpayers are facing an enormous future liability to pay for the government bailout of the financial industry. Canadian taxpayers could face a similar liability because our government is so heavily involved in the mortgage insurance market through the CMHC,"

The report, written by researcher Neil Mohindra, examines the mortgage finance models in use in Australia and Canada, as well as the European covered bond model, focusing on the question of how to minimize risk to taxpayers while still achieving the housing objectives espoused by government policy-makers.

Australia had its own sub-prime debacle in the 1980s when a state government securitization agency created a program to fund mortgages for low-income borrowers. The program was a disaster and resulted in taxpayer losses of close to half a billion Australian dollars.

Once the Australian state governments got out of the mortgage securitization market, the private sector became active in securitizing residential mortgages. The Australian federal government also exited mortgage insurance by privatizing its mortgage insurer.

The study finds that home-ownership rates in the period following the privatization showed no adverse effects from the lack of government involvement in mortgage finance. In fact, the proportion of Australian homeowners relying on mortgage finance increased and housing quality improved.

"The Australian experience shows that a market for mortgage insurance can operate effectively without any form of government guarantee,"

"In order to lessen the taxpayer exposure and reduce the likelihood of a Canadian mortgage crisis, the government should emulate Australia and allow the private sector to take total responsibility for insuring and securitizing Canadian residential mortgages."

Stephen Jarislowsky, chairman of Montreal-based investment adviser Jarislowsky Fraser Ltd., said he is “convinced” there’s a bubble in Canada’s housing market, fueled by government measures that encouraged consumers to take on debt.

“They have basically encouraged people to buy houses based on cheap mortgages,” Jarislowsky, 84, said in a telephone interview from Montreal. “That has created the opposite effect of what was desirable.”

Canadian home prices and resales will grow to records this year, boosted by low interest rates, the Canadian Real Estate Association said in a report this week. Canadian new-home prices rose 0.4 percent in December from the previous month, the sixth straight gain, government figures showed yesterday.

“I am convinced there is a housing bubble in Canada,” said Jarislowsky, whose investment fund owns shares in Canada’s four biggest banks, including Toronto-based Royal Bank of Canada.

The comments by Jarislowsky, who is one of Canada’s wealthiest investors with a fortune worth C$1.85 billion ($1.8 billion) according to Canadian Business magazine, contrast with the view held by Finance Minister Jim Flaherty, who sees “no clear evidence” of a housing bubble, his spokesman, Chisholm Pothier, said this week. 

Government intervention in the mortgage insurance market is exposing Canadian taxpayers to enormous potential liabilities if Canada were to be hit with a mortgage default crisis similar to what occurred in the United States, according to a new peer-reviewed study released today by the Fraser Institute, Canada's leading public policy think-tank.

The report, Mortgage Finance Reform: Protecting Taxpayers from Liability, finds that the Canadian government is heavily exposed in the mortgage market because 43 per cent of all residential mortgages (including all loan-to-value mortgages over 80 per cent) are backed by the government through the federally owned Canada Mortgage and Housing Corporation (CMHC).

The report recommends that the federal government follow Australia's example by opening Canada's mortgage insurance market to full competition including the privatization of the CMHC.

"The CMHC dominates the Canadian mortgage insurance market because it enjoys regulatory advantages not available to private-sector companies. As a result, several private-sector mortgage companies have withdrawn from offering mortgage insurance in Canada," said Dr. Brett J. Skinner, Fraser Institute director of insurance policy research.

"The Canadian government should reduce taxpayer exposure by allowing the private sector to take responsibility for insuring and securitizing Canadian residential mortgages. This includes the complete privatization of the CMHC's mortgage insurance business."

The report points out that the Canadian model has the majority of risk concentrated with the Government of Canada, and therefore the taxpayer liability is much greater in Canada than in Australia. By privatizing the CMHC or removing its unfair regulatory advantages, the market would likely be more pluralistic with multiple mortgage insurance providers serving Canadians.

This would be similar to the Australian model of mortgage financing, which has been highly successful in achieving home ownership outcomes and has produced a stable mortgage market, but has minimized taxpayer liabilities during financial crises.

With interest rates at a record low, a growing number of people are looking to purchase a home. Every homebuyer faces the age-old question of whether to choose a fixed or variable rate mortgage.

"The question of whether to lock in to a longer-term fixed mortgage rate or stay in a variable rate has become an increasingly complex and important debate," said Doug Porter, Deputy Chief Economist, BMO Capital Markets.

"Short-term rates are at historic lows and pressure is likely to build for higher rates in the year ahead."
Research shows that over the past 30 years it has been more cost-effective for borrowers to have a variable rate mortgage 82 per cent of the time. However, under the current environment, Porter points out there are a number of factors to consider before assuming the variable rate is the hands-down winner:

-  Canada has been in a long-term declining rate environment since the
        early 1980s.
     -  The Bank of Canada's overnight rate is now as low as it can go, so
        there is no further downside for variable rates. The surprises can
        only be to the high side from here.
     -  Fixed rates were advantageous during only two recent periods - through
        the late 1970s and in the late 1980s; in both cases ahead of a period
        of rising interest rates, as is the case now.

The Case for Staying Fixed

A conventional fixed rate mortgage can mitigate a number of risks. Although inflation has not been a problem since 1991, there is a risk of an inflation flare-up as global central banks keep the pedal to the policy metal, and amid record government deficits.

The Bank of Canada could be forced to raise interest rates aggressively, driving variable mortgage rates higher, but leaving Canadians with fixed rates relatively unscathed. Plus, fixed rates are currently very attractive given that short-term rates are already as low as they can go.

The Case for Going Variable

The advantage to a variable rate mortgage is that it has been consistently less costly over time. As well, the current outlook for inflation remains benign, which will likely keep price pressures at bay well into 2011. The soaring Canadian dollar is putting additional downward pressure on prices, reducing the near-term need for the Bank of Canada to raise rates.

There is also some risk to locking in as fixed rates could fall if the economy performs worse than anticipated. Even as rates start to rise, Canadians can always lock into a fixed rate at a later date.

The decision depends on the individual. For those who do not have a lot of financial flexibility - such as first-time home buyers and those who would run into difficulty from an upswing in interest rates - the moderate extra cost of peace of mind you can get from a fixed rate may be a price worth paying.

There is also a reasonable scenario where fixed rates may actually prove to be a cheaper alternative at this point. That's particularly the case given some recent cuts in long-term fixed rates, such as BMO's current special rate of 4.09 per cent for a five-year fixed mortgage. BMO Economics' view is that variable rates will climb only moderately, but by enough to tilt the balance in favour of current fixed rates.

"The most important thing a current or first-time homeowner can do is talk to a knowledgeable mortgage expert about their situation and make decisions based on their particular circumstances," said Jane Yuen, Senior Manager, Mortgages, BMO Bank of Montreal. "So come in to a branch or contact a mortgage expert to decide on the type of mortgage that is best for you at this point in your life."

"We would, in essence, be dousing the entire Canadian economy

with cold water, just as it emerges from recession," Wolf said in an Edmonton speech delivered on behalf of deputy governor Timothy Lane, who could not travel to the Alberta capital for personal reasons.

"As a result, it would take longer for economic growth to return to potential and for inflation to get back to target," he added.

Finance Minister Jim Flaherty has also openly discussed policy measures to cool the housing market, including raising the minimum down payment requirement above five per cent, or reducing the maximum length a residential mortgage can be amortized from the current 35 years.

Monday's speech came hours after Canada Mortgage and Housing Corp. released a report indicating the annual rate of housing starts reached 174,500 units in December, up nearly 10,000 from November.

The organization said the improvement in housing starts was broad-based, with solid increases in both single and multiple starts to end the year.

Klump said the rise in new supply in market as well as increase in resale market will let some of the air out of tires in the balance between supply and demand, adding that as 2010 progresses price increases will shrink to the rate of inflation.

Wolf said that even if the bank judged that housing prices were getting out of hand, raising interest rates is too blunt an instrument since it would have the effect of cooling off the entire economy.

Statistics Canada also released figures Monday that pointed toward growth in the housing sector, showing construction intentions in the residential sector are starting to approach their pre-downturn levels, rising 9.1 per cent in November to $3.8 billion.

Contractors took out $5.9 billion in building permits in November, down 4.6 per cent from October.

But Statistics Canada reports that they were 23.1 per cent higher than November 2008 and 62.8 per cent above February 2009, when their value bottomed out amid the economic downturn.

Klump said the current hot market is unlikely to cause a bubble because the economy is on an upward swing, reducing the probability of a massive decline in housing demand.

"I don't see where the catalyst is going to come from for some kind of massive decline or popping of any quote unquote bubble," he said.