Canada’s housing market among most ‘bubbly’ in world: Economist

The international warnings about Canada’s overheated housing market continue with a report from The Economist showing ours is among the most overvalued in the world.

The report says Canada’s housing market is the second-most expensive among 19 nations surveyed when measured by price-to-rent, and among the top three when it comes to price-to-income.

“If these ratios are higher than their historical averages … property is overvalued; if they are lower it is undervalued. On this basis, Canada’s house prices are bubbly whereas Japan’s are undeservedly flat,” the magazine said in its latest issue.

Canada ranked second behind Hong Kong when comparing the relationship between the costs of buying and renting, and third behind Belgium and France when comparing house prices against average incomes. Japan ranked at the bottom by both measures.

The Economist report follows a similar study released in June from the Organisation for Economic Cooperation and Development (OECD) saying house prices in Canada are overvalued by as much as 30 per cent, using similar price-to-income and price-to-rent data.

While economists agree Canadian home prices have run up, many argue the metrics used in both reports are too simplistic.

"Simple metrics such as the price-to-rent ratio vastly overestimate the degree of house price overvaluation in Canada," Scotiabank economist Adrienne Warren said in a recent report.

For instance, Warren says the average rental unit in Canada is smaller, older and lower quality than houses that are owned. She suggests a better comparison is average condominium prices relative to rents, although such long-term data isn’t available.

“Many households are willing to pay a premium to own a home rather than rent, whether for lifestyle considerations or expectations of capital appreciation,” she says, adding her belief the average price-to-rent ratio in Canada has peaked and will gradually fall over the next decade.

At the same time, rents are rising in cities such as Toronto, which will also close the gap.

Both reports about Canada’s overheated housing market come as it continues to digest federal government measures put in place to try to prevent a U.S.-style market crash. Last summer, Ottawa cut the maximum amortization period for an insured home loan to 25 years from 30. It was the fourth pullback in mortgage rules in as many years.

The measures did manage to slow down sales and ease prices across Canada, but housing activity has bounced back in recent months. Economists say that is partially in response to rising mortgage rates, as buyers take advantage of preapproved rates.

Canada’s big banks have increased mortgage rates in recent weeks, putting an end to the era of rock-bottom borrowing costs.

Rising interest rates will also help to cool Canada’s market. TD Bank estimates that for every percentage point increase in interest rates there is an instant increase in sales of 6 percentage points, as buyers rush to take advantage of lower rates. That is followed by a 7-per-cent decline in the months that follow, TD says.

“The net impact is a 1 percentage point permanent decline in existing home sales due to every 1 percentage point increase in interest rates,” the bank says.

Still, most Canadian economists don't expect housing prices to plunge in Canada, despite dire predictions to the contrary from outside investors, particularly those who have a "short Canada" stance on the country.

"Overall we don't see a major price adjustment," in Canada's housing market, TD economist Derek Burleton told BNN on Wednesday.

He said the price-to-income ratio has flattened in recent years, and household debt levels – which hit a record in the fourth quarter of 2012 – have dropped.

"It's going to be a cautious consumer, but overall I think it's a necessary adjustment," Burleton said.