Canadian housing market 'over-valued' by nearly 15% says bank

Canada’s booming house prices are 10% to 15% over-valued, the country’s second-biggest bank Toronto-Dominion warned this week, as its chief economist Craig Alexander called for the government to put the brakes on lending growth.

According to Alexander, if Canada’s overvalued residential market were to suddenly unravel, the market correction would be three times the magnitude of the country’s housing market crash in the early 1990s.

He would like to see “a gradual decline in sales and prices over the next several years.”

“We need to acknowledge that a significant imbalance has developed and it poses a clear and present danger to Canada’s medium-term economic outlook,” he says. “It also suggests that further actions to constrain lending growth may be prudent.”

At greatest risk is Vancouver, a magnet for foreign buyers, along with the Toronto condo market, and the broad housing markets in Quebec City and Montreal, says Alexander. “Nevertheless, beyond selected cities, it is natural to assume that it will be a shock to all real estate markets when interest rates eventually rise from their prevailing exceedingly low levels,” he said.

Local agent and OPP Canadian correspondent Nicola Way is staying calm about the prospect of the market overheating.

“Current reports indicate that the Bank of Canada may raise interest rates towards the end of 2012,” she told OPP this week.

“Therefore a small raise may cause a soft correction in home sales and prices, but it’s not going to be the dramatic bubble burst that the US saw with their sub-prime fiasco.”

“Canada’s conservative lending practice means that any interest rate increase will be rolled out slowly to avoid household debt escalating too quickly,” Way adds.

But “increasing debt is definitely an issue that is being monitored and one way to regulate it is for banks to shorten the maximum amortisation period (the length of time in which a mortgage needs to be repaid) from the current 30 years, to 25. That way homeowners will carry loans that have lower costs over the long term.”

Does Way, who runs think that overseas property buyers notice any difference if prices and lending terms in Canada do adjust?

“No,” she says, because “many purchase with cash, thereby negating exposure to domestic interest rate adjustments. The recent Knight Frank Global House Price Index showed that over the last 5 years (and through many different interest rate changes) Canada achieved a 28.7% house price increase. It’s these long-term statistics that most overseas buyers consider, together with the other opportunities that Canada presents in terms of education, lifestyle, stability, safety, etc.”

Another factor worrying economists in Canada at present is the country’s spiralling levels of household debt. Toronto-Dominion’s Craig Alexander predicts that by late 2013 the ratio will reach the 160% peak seen in the United States and Britain before their real estate corrections.

Alexander said the Bank of Canada, which has repeatedly voiced concern over housing prices and household debt, is in a bind because if it raises rates while the U.S. Federal Reserve holds rates steady, that would boost the Canadian dollar further and slow growth.

A majority of forecasters polled by Reuters last month predicted that the Canadian government would tighten mortgage rules this year.