Canadians spent a higher portion of their income on housing in the fourth quarter, as high home prices and utility costs pushed affordability to its worst level in a decade, said a report by the Royal Bank of Canada.
That deterioration is coming at the end of ten years of generally 'excellent' affordability conditions, the report by the bank's economics department noted.
And, while affordability will likely continue to slide in the first half of this year, rising incomes and steady interest rates and house prices should stop the declines in 2007, economists said.
RBC Financial Group's (TSX: RY) latest housing affordability index, measures the proportion of pre-tax household income needed to service the costs of owning a home.
Such surveys are a popular promotional tool for Canada's banks and mutual fund companies. Many use public opinion polls to gauge demand for financial products and services, promote specific brand names and learn more about the public's financial management habits.
All the banks are focused on the housing market since mortgage lending is one of their key sources of profit and the average mortgage borrowed by homebuyers has been growing in recent years as house prices have soared.
Last year ended on a 'mildly sour note' after three quarters of improvement, the bank said, with housing affordability deteriorating across the country.
The worst-hit cities were Vancouver and Calgary, where house prices escalated rapidly as the economies in those energy- and mineral-rich western provinces grew faster than than the Canadian average.
While the markets in British Columbia and Alberta "continue to power forward," Royal Bank expects the pace of demand for new and existing homes in the rest of the country to slow moderately over the next two years because of the decline in affordability.
It will be "a controlled slowdown, with both new supply and demand expected to cool down simultaneously," the report said.
Much of the drop in affordability stems from slower growth in household income, said Derek Holt, the Royal Bank's assistant chief economist.
"This was unable to offset increases in mortgage rates, house prices and utilities costs," he said.
Benjamin Tal, senior economist at CIBC World Markets, expects affordability to get worse before getting better.
"Income growth in Canada is starting to accelerate, wages are rising," Tal said. "But the increase in house prices has been faster. Add to it higher interest rates, and the overall size of mortgages is rising, so affordability is going down."
The impact of rising interest rates has been more pronounced, Tal said, because about 22 per cent of mortgages are now variable-rate — moving with the bank's prime lending rate — rather than being fixed at long-term rates.
"With interest rates rising by maybe another (quarter to half point), we probably will see affordability continue to deteriorate, at least for the next few months," he said.
Beyond that, he expects it to stabilize because interest rates will stop rising, house prices will level off, and Tal predicts that incomes will be stronger than expected.
"So, I think affordability will not be much worse a year from now. It might even be better."
The housing market's soft landing will be supported by growth in home renovation spending, the Royal Bank report said.
Canada's renovation spending has grown by more than 50 per cent since 2000, to over $26 billion in 2005.
"While the recent takeoff in renovation spending is taken by some to be a sign of a bubble, our view is that homes built in the 1980s boom will continue to enter their prime renovation years, such that growth in renovation spending will partly offset weaker new home construction," the report said.
Ontario, in the meantime, is seeing new home construction decline as construction workers flock to Alberta.
Last year, housing starts in Ontario pulled back 7.4 per cent while residential building permits dropped for the first time in a decade.
"Migration and housing starts tend to move closely together in Ontario," Holt said. "Labour-hungry western provinces, most notably Alberta and British Columbia, continue to pull workers from other provinces, putting downward pressure on new home construction in Ontario, which still remains at elevated levels."
Wednesday's report suggests that condominiums were the most affordable Canadian housing type during the fourth quarter, with an index of 25.7 per cent. A standard townhouse is next at 30.1 per cent, followed by a detached bungalow at 37 per cent.
A two-storey home remains the least affordable type with an index reading of 43 per cent.