Is Victoria overpriced?

When the Canada Mortgage Housing Corporation says something about the housing market in Canada, the media listens up. After all, they’re the supposed authority on housing with a 75-year history of building, financing, and regulating housing in Canada. If anyone has the data necessary for insights into where the market is going, surely it’s the CMHC.

Since 2015 they have been producing periodic Housing Market Assessment reports, whose stated purpose is to “identify significant imbalances in the housing market that could potentially increase the risk and consequences of a housing market downturn.” In other words, they are trying to spot a bubble in housing that could lead to a dangerous decline in prices like what was seen in the US market in 2008. With prices at all-time highs from coast to coast and affordability deteriorating at the fastest rate in 30 years, one must wonder what it would take for the CMHC to dust off the old alarm bells.

We’ve recently been through an economic shock from COVID, and CMHC came out in May of 2020 with a bold forecast that house prices would decline 9-18% within 12 months and remain depressed until 2022. In reality, average national prices jumped 33% in a year and remain near their peak. Victoria is no exception, with the average price of all transactions up 22% from pre-COVID levels, and single-family home prices up more than 30%.

It’s not fair to be too critical of the CMHC for this particular missed forecast, though. After all, the world has never seen anything like COVID, so it’s understandable that the existing models produced incorrect results in the face of a novel crisis. No mainstream observers predicted the epic price boom (though our own forecast early in the pandemic came much closer to the truth). Hopefully the CMHC learned their lesson about being overconfident in the face of unprecedented uncertainty.

Do restaurant worker wages affect million-dollar home prices?

Returning to their Housing Market Assessments, they recently released the fall update, and concluded that although the Canadian market as a whole was highly vulnerable to a price decline, Victoria was only moderately vulnerable and showed no signs of overvaluation. Given we’ve just seen the biggest increase in house prices in Victoria’s history, that seems surprising to say the least.

Their rationale for the assessment was equally mystifying, stating that the recovery in food and accommodation sector jobs were supportive of higher prices. With most food and hospitality workers struggling to earn a living wage—let alone anything approaching enough to save for a down payment on a home—it defies logic to suggest that higher employment in those sectors would raise the prices of homes that are already so far out of their reach. The CMHC report came close to admitting as much; after touting the rises in wages as the primary driver of rises in home prices, its author concluded that “actual home price outpaced economic gains.”

A more realistic factor identified in the report is the return of out-of-town buyers, primarily from Vancouver. That was a major factor in Victoria’s price runup four years ago, and they returned with a vengeance after the pandemic hit. The VREB Buyer Origin Survey indicates that buyers moving from the Lower Mainland made up 7.1% in the pre-pandemic quarter, which jumped to an average of 10.5% of all sales in the last 12 months. That was particularly strongly felt in the luxury market, with 285 sales over $2 million so far this year compared to 65 in the same period 2019. Three quarters of buyers in Victoria are still locals, but with record low inventory, a steady stream of out-of-town buyers less dependent on local incomes can certainly put pressure on prices.

Overvalued

To find out what that overvaluation metric might be telling us, we went back through each of CMHC’s reports and charted their assessment of our level of overvaluation vs actual house prices. Those are pictured below. ‍

The CMHC said prices were overvalued just one since 2016. Prices have risen 65%. Image: Leo Spalteholz

The last time CMHC determined that there was a low risk of overvaluation in Victoria’s prices was in 2016. However, since then, house prices have risen about 65%, to a median of near $1.1 million in September. Just three years ago when houses only cost $800,000 and condos half that, CMHC thought we were highly overvalued. How is it possible that $800,000 is highly overvalued, but $1.1 million is not, without profound changes to the rest of the market conditions in the intervening years? A drop in interest rates is one factor, but as you may be starting to tell, CMHC’s measure of overvaluation has not had predictive value about the direction of house prices in Victoria.

That said, their assessment that there is only moderate risk in Victoria’s market may well be correct. Rock-bottom interest rates mean that although prices have jumped, in relation to incomes the mortgage payments are only slightly harder to carry than last year. Compared to long run averages for Victoria, affordability is deteriorating but isn’t outside of the historical ranges. Of course those low rates can only be taken advantage of by those with enough wealth for the increasingly large down payment, and enough income (or willing co-signers) to pass the mortgage stress test, which requires borrowers to qualify at a mortgage rate of 5.25%. That has led to a grim housing duality, where those with means or already in the market are able to afford Victoria, while those without suffer from the increasing rental shortage and a high barrier to entry for ownership.

Mortgage payments are approaching highs usually seen before recessions.

In the short term with continued elevated demand set against a chronic lack of supply that has driven inventory to all time lows, most signs still point toward higher prices to come. Unlike the CMHC though, I won’t make the mistake of making a definitive prediction.