By Brent Hannon

Canada's residential property market is ticking along like a well-tuned engine, posting average annual price increases of 5% to 10% countrywide for the past three years, continuing an era of healthy appreciation that began in 1999. In many respects, Canada is a model residential market: demand and supply are in balance; homes remain affordable; and annual price increases have been solid but not supercharged.

"The price growth for Canadian housing has been quite steady in the past three years," says Peter Norman, vice president of Clayton Research, a Toronto-based consultancy that studies Canadian property. "Resale housing prices have been rising across the country in the 8% to 10% range, and new housing prices have been rising in the 5% to 7% range year-over-year, and those numbers have been consistent for the past three years."

Property demand is robust across Canada, fueled by low interest rates, strong employment growth, affordable property and high consumer confidence. The sluggishness of investment alternatives is also driving demand for home purchases, says Gregory Klump, chief economist for the Canadian Real Estate Association, a trade association based in Ottawa.

Despite strong demand, Canadian homes have not experienced the dramatic price rises that have typified markets in the U.S., the U.K. and Australia, where home prices have jumped 25% or more in recent years. "Canada's long-term healthy expansion is much greater than inflation, but without the runaway price increases that many Western markets are experiencing," says Phil Soper, president and CEO of Royal LePage Real Estate Services in Toronto.

Why has Canadian residential property not suffered the same feverish appreciation as other Western markets? Mr. Norman believes it is because supply has kept pace with demand. "The Canadian marketplace is much different than the U.S., the U.K. and Australia," he says. "We also have a tremendous amount of housing demand, but our supply has come on stream in a very timely manner, so the market is very much in balance."

A robust supply of condominiums acts as a safety valve in key Canadian cities, releasing demand pressure in downtown urban cores. Vancouver and Toronto are very active condo-building markets, with annual new supply far outstripping most U.S. cities. In locations where supply can't increase as quickly -- homes in coveted city neighborhoods, and unique vacation properties -- annual appreciation tends to exceed the national average.

Policy measures have also helped keep price increases under control. Mortgage interest is not tax deductible in Canada, unlike the U.S., and market-specific measures also apply in some cities and provinces, such as requiring down payments of up to 25% and levying high taxes on profits from property sales.

The cumulative effect of these rules is to reduce speculative investment. "In the U.S. last year, 36% of transactions were for nonprincipal residents, and those transactions were either for recreational property or, more likely, for speculation in residential real estate," says Mr. Soper of Royal LePage. "The amount of speculation that goes on in the Canadian market is much less, which acts as a counter-stimulus."

The strong Canadian currency -- about 80 cents to the U.S. dollar, up from 62 cents five years ago -- has reduced international demand, especially from U.S. buyers, says Mark Lester, Vancouver-based vice president of Unique Properties Group, Colliers International. Because annual appreciation has been modest, Canadian homes are reasonably priced compared with other Western markets, says Mr. Norman of Clayton Research. "If you look at Canadian property prices right now, they're pretty much the lowest in the world, if you denominate prices against average household income, which is a good way to look at it in an international context," he says.

Even at the high end of the market -- luxury properties in good downtown locations and waterfront resorts -- property remains affordable by international standards. Mr. Lester's Unique Properties Group, which sells islands, peninsulas, ranches and other high-price property, still makes most of its sales to Americans -- though it's now closer to 50% of purchases, down from 70% five years ago -- who still find Canadian property a bargain despite recent appreciation. "On the coast of British Columbia, we've seen [standard waterfront property] going from C$400,000 (US$323,000) to C$600,000 in three years, for a one- or two-acre property on the water, with a house and ferry access," he says.

Buyers looking for bargains in recreational property should scout new locations that mirror the success of established destinations, says Mr. Soper. Whistler, B.C., is famous but expensive, while Kimberley, B.C., has similar scenery, is better value and close to Vancouver. Likewise, Fernie, B.C., is an up-and-coming version of Canmore, Alberta, while outside Toronto, as an alternative to pricey Lake Muskoka, cheaper lakeside property is available near Kingston. "These are developing recreational regions in Canada where you can get a much better deal," says Mr. Soper.

For urban property, the decision is easy, says Mr. Soper: Go to Alberta, which has the second-largest oil reserves in the world, behind Saudi Arabia. With oil companies moving in, the economy should boom. "There will be continuing investment in the coming decade in Calgary and Edmonton, and in the heart of the oil sands, Fort McMurray," he says. "All of those are excellent bets for the future."

Potential buyers should be aware that housing demand is expected to slow in Canada this year, due to a demographic shift that will gradually put the brakes on growth. Much of Canada's residential demand is driven by first-time home buyers, who have accounted for about 70% of all transactions in the past two years, fueled by low interest rates and the supply of new and reasonably priced condos. As this bulge moves through the marketplace, and demand from that niche declines, annual price appreciation is expected to slow.

But while analysts have been predicting a slowdown for several years, it hasn't happened yet. In the first quarter of this year, residential property prices were stronger than expected. According to the Canadian Real Estate Association, the value of existing home sales in major markets via the Multiple Listing Service rose 8% in the first quarter to an average C$254,000, compared with the first quarter of 2004. In many markets, including Vancouver, Calgary, Edmonton, Toronto, Ottawa and Montreal, average home prices set new quarterly records.

Nonetheless, key indicators are easing. Unit sales fell 1% in March, compared with February, with dollar volume (the total amount spent on all property transactions) and new listings also down slightly.

"Unit sales reached a peak last year and we expect them to lose momentum as prices increase, but, that said, there will still be strong sales given the low level interest rates will stay at, and given recent job growth," says Mr. Klump of the Canadian Real Estate Association. Consumers currently pay about 4.8% to 5% for a five-year fixed mortgage.

The expected market-softening is likely to be gentle, and no one is predicting precipitous declines in value. "More than a soft landing, I would predict a feather-bed landing," says Mr. Klump. "Prices will stay high, unit sales will remain strong and there's not going to be any bust. The market will continue to return to more normal levels, but it will get there at a very slow pace."