Canada’s housing bubble fears due to ‘wildly inaccurate estimates’: economist

With all of the talk about a housing bubble in Canada, homeowners may find comfort in a new report suggesting the market could actually be undervalued.

That’s right, undervalued.

Maybe you don’t have to worry about trying to sell at the top of the market after all. For buyers, now might not be the worst time to get in.

At least, that’s the takeaway from housing industry economist Will Dunning who dispels the housing bubble myth and takes aim at doomsayers who believe we’re all living under overpriced roofs.

In a new report called How to Dissect a Housing Bubble, Dunning says a study from the Organization for Economic Co-operation and Development (OECD) suggesting Canada has one of the world’s most over-valued housing markets in the world uses “wildly inaccurate estimates.”

He says the house price-to-rent statistics used by the OECD are “badly flawed.” Instead of relying on the Teranet/National Bank National Composite House Price Index and Consumer Price Index, he says the Royal LePage House Price Survey is more accurate. It shows the price-to-rent ratio in Canada has increased, but by much less than the OECD estimates.

In fact, his reading of this other measure shows the price of your house might continue to go up by as much as 25 per cent over the next two years, depending on what happens with interest rates.

Dunning cites a “large gap” in his calculations between the current ratio of rents versus prices, in comparison to mortgage interest rates.

“The result is that there is room to accommodate a sizeable increase in house prices (as much as 20% to 25% during the next two years) and/or rises in interest rates (as much as one percentage point from current levels),” writes Dunning, who is also chief economist for the Canadian Association of Accredited Mortgage Professionals.

“Thus, rather than being over-valued, house prices in Canada are fairly-valued, and they may even be under-valued.”

Canadians aren’t dumb, he adds. They know that interest rates can rise. Still “they have been prudent, with the result that the housing market has left a considerable amount of room to absorb a future rise in interest costs.”

It’s the latest in a growing list of reports trying to predict the future of Canada’s housing market, particularly after it defied expectations throughout most of 2013.

Last month, TD Bank also criticized the OECD findings suggesting Canada’s market is overvalued by about 60 per cent. Instead, TD forecasts the market is overvalued by about 10 per cent. Its argument was based on housing affordability measures and not the price-to-rent ratio and the price-to-income ratios being used to predict a bubble.

“Both these measures fail to take into account the drop in interest rates over the last two decades,” TD economist Diana Petramala said in her report. “What really matters is housing affordability.”

It’s the threat of rising interest rates that led to her call that the market is somewhat overvalued, but well below the extent the OECD and others predict.

“If we assume a more normal interest rate environment, the index points to a 25 per cent overvaluation. On the other extreme, using current interest rates points to a market that is fairly valued,” she wrote.

In her opinion, based on a forecast that interest rates are expected to eventually rise, Petramala believes home prices are "likely roughly 10 per cent overvalued.”

Dunning’s report notes conditions vary across the Canada. He said Vancouver, Canada’s most-expensive market, was “showing characteristics of a bubble,” but that has been deflated “in a surprisingly orderly way.” He also claims Alberta had a short-lived bubble in 2006-07.

As for the country being overbuilt, Dunning isn’t worried: “Actual housing construction exceeds the so-called ‘demographic requirement’,” he writes. “We should not be concerned about that: if too much housing was being produced we would be seeing high vacancies in the rental market and excess supply in the resale market. Housing supply and demand have been in balance in Canada.”

One thing we know for sure: This definitely won’t be the last word on the future direction of Canada’s controversial housing market.