Toronto house prices could slide

The latest data on the Toronto housing market shows that a sharp decline in sales has yet to trigger a drop in prices. However, a major indicator of market conditions suggests this could change soon.

The ratio of Toronto sales to new listings slumped to 41% in May, according to data released by the Canadian Real Estate Association (CREA) last Thursday. That’s the lowest it’s been since 2008 and is near the bottom of the range for what economists generally consider a balanced market.

This gauge is a pretty good predictor of home prices, and what it’s showing (based on the typical historical relationship between these two variables) is that a modest price decline is fairly certain.

According to Bloomberg’s calculations, the three-month moving average of sales to the new listings ratio explains nearly 60% of the variation in the Toronto benchmark home prices five months later. A sustained ratio of 40% suggests small, single-digit annual price declines in about half a year.

Most economists, including the Bank of Canada (BoC) believe home prices are headed for a soft landing. They’ve been climbing steadily for years, and the recent run of annual gains in excess of 30% was bound to end. Even amid the sales decline last month, Toronto benchmark prices were up 1.2% in May.

The soft landing predicted by the model, however, assumes there will be a smooth and orderly correction, whereas Toronto dynamics seem to be out of control. In its recent semi-annual financial system review, BoC said a sharp price correction in Toronto and Vancouver is unlikely because strong underlying fundamentals “support the idea that a downturn in prices would be limited.”

This view was given added credence when BoC Governor Stephen Poloz and Senior Deputy Governor Carolyn Wilkins recently suggested that the Canadian economy was strong enough to withstand the gradual withdrawal of stimulus. Essentially, the policymakers are saying they’re comfortable enough with the situation in the Toronto and Vancouver real estate markets to risk the possible fallout from higher borrowing costs.

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