Is the house-price bubble about to pop?

With the bond market edging upward and Bank of Canada governor David Dodge predicting a steady rise in interest rates worldwide by next year, many are wondering whether Greater Vancouver’s inflated housing market — which has seen average prices hit $348,084, highest in the country — can hold up.

A fall in home prices could ripple through the entire economy as North Americans have taken on record levels of debt, largely on the strength of the equity in their homes, the pessimists warn.

If house values drop while interest rates rise, many families could find themselves overextended. Suddenly the payments on loans and lines of credit would jump, foreclosures would rise and the consumer spending spree that has powered the economy through the last three years would screech to a halt.

Simon Fraser University business professor Lindsay Meredith sees ominous signs in today’s combination of rock-bottom interest rates, a rapid rise in home prices, brisk remortgaging activity and the Canada Mortgage and Housing Corp.’s new “no money down” policy for first-time buyers.

“There you have the components of a time bomb,” he said. Any sudden rise in interest rates or economic shock could cause young buyers lured into the market by cheaper-than-rent financing to default or even walk away from their purchases.

“These people are holding no equity,” Meredith said. “What does he do if he loses his job? He rips out the sink, the toilet and the electrical and he walks.”

Even longtime homeowners could find themselves stretched thin if they refinance their homes, use the savings to renovate, then get stuck with higher mortgage payments down the line.

“What we have here are artificial factors driving up the market,” said Meredith, who predicts a housing crash should mortgage rates climb above eight per cent.

While he doesn’t foresee “a big crash and burn,” University of B.C. professor Stan Hamilton expects a “correction” in house prices if interest rates rise 50 to 75 basis points (a half to three-quarters of a percentage point) over the next year.

With interest rates so low, such an increase makes a significant difference in monthly payments, noted Hamilton, who teaches finance and real estate at the Sauder School of Business.

“Going from 10 to 10 1/2 [per cent] doesn’t make such a difference as five to 5 1/2,” he said.

Hamilton believes there is more risk of a market drop this time than after the last market peak in 1995 because the required down payment has dropped to five per cent of the purchase price — and in some cases zero — from 10 per cent.

“We’ve dug into the buyer’s side of the market to the point where people are in debt to the hilt,” he said.

Real Estate Board of Greater Vancouver president Andrew Peck concedes that interest rates can only go up, but believes other factors, such as low housing supply and an improving economy will forestall any price drop.

“It’s not just an interest-rate-driven environment,” he said.

Carol Frketich, regional economist for CMHC, likewise foresees an orderly transition to a new stage of the real-estate cycle.

“Yes, they will have a dampening effect,” she said of higher interest rates. But while sales activity will slow down, house prices will likely continue to rise for another two years, she said.

The factors that stuck Ontario homeowners with mortgages worth more than their homes in the early 1990s, for example, simply aren’t in place in B.C. right now. The bursting of Ontario‘s bubble was accompanied by a severe recession and too many new homes coming on the market.

Though housing starts should exceed 27,000 in B.C. this year, Frketich said, that is coming off a low of 14,418 in 2000 and well short of the 40,000-plus built in 1990. And most of the condominium and townhouse projects going up are pre-sold, meaning there will be no glut of homes for sale.

As for B.C.’s economy, it’s just picking up steam and attracting new arrivals from other provinces after six years of inter-provincial outflows, Frketich said.

The market’s rise since 2000 has been fuelled by pent-up demand from first-time buyers and investors taking advantage of the lowest interest rates in nearly half a century, Frketich said. While higher interest rates may take some of those buyers out of the market, they will be replaced by migrants once again moving into B.C.

One indication that demand continues to outpace supply is the high ratio of home sales to listings, Frketich said. As a result, prices will likely continue to creep up — though at a slower pace than before — until sales and listings come back into balance. CMHC predicts the average price of homes in metropolitan Vancouver to rise another eight to 12 per cent this year.

Even after the peak, don’t expect a sudden price drop, she added. When prices get high, opportunistic homeowners often put their homes on the market “just to see what they can get” and take them off again as prices recede, making the resale market “sticky on the downside.”

And though home prices in Greater Vancouver may look sky-high, they are 10-per-cent lower on average than in January 1995, the last market peak, when adjusted for inflation. Moreover the 11-per-cent average increase in the region last year pales against the 20- to 30-per-cent annual increases recorded in the late 1980s.

© The Vancouver Sun 2004