What Causes Overinflated House Prices

money house

What Causes Overinflated House Prices

In past blog posts, we have looked at the increase in Toronto’s real estate prices. We even explored Why CMHC Considers the Toronto Market Risky. But what triggers a market to rise, instead of simply moving sideways or even falling? Today, let’s explore what causes overinflated house prices.

Location, Location, Location

I know I’ve said it before, but this real estate catchphrase is still true. Location is one of the biggest factors in high prices. Location also contributes to certain markets becoming overinflated. Just look at Toronto and Vancouver – they are still seeing double-digit increases in real estate prices. Hot neighbourhoods in any big city will have wild price increases every so often.

Increase in Demand

Like pricing for most goods and services, supply and demand also plays a big role in determining real estate prices. With the exception of the Calgary area, we’re still seeing good demand for real estate throughout the country. This can be attributed to many causes: a general rise in population, more people wanting to live in the downtown core, even first time buyers afraid to get priced out of the market.

Easy Access to Credit

In the last decade, it’s been easier than ever to get access to credit. Although the Federal Government has tightened mortgage rules in the past few years, it’s still possible to qualify for very large loans. Many Canadians have taken those high credit limits and gone house shopping. Easy credit typically drives up real estate prices, since potential home buyers have access to enough funds to pay top dollar.

Low-Interest Rates

Low-interest rates also contribute to overinflated house prices. Today’s low rates mean smaller mortgage payments, even though house prices have gone up significantly. That encourages buyers to spend more on their house, since they can still afford the current payments.

Overconfidence

Many home buyers have high hopes for the Canadian real estate market. Since prices just keep climbing, many are confident there’s nowhere to go but up. Overconfidence in the market leads to higher risk taking. Some buy more house than they can afford simply because they believe it will be a good investment, counting on appreciation. But making decisions based on past performance can be dangerous. Speculation in the hottest real estate markets can be a lot like gambling – and it’s driving up house prices.

Inflation

Due to inflation, it’s normal for prices to go up. However, recent increases in major Canadian markets go well beyond regular inflation rates. Here in Toronto, we have seen a year-over-year increase of 13.6 percent in the average selling price for the first quarter of 2016. (TREB) To compare, the rate of inflation for Canada has been just under 2 per cent. (Statistics Canada)

So what can we expect going forward? Will house prices continue to go up in Canada? For another point of view on the matter, check out MoneySense magazine’s article: Canadian real estate market outlook 2016.

Do you think the Canadian real estate market is overinflated?