Toronto home prices among top 3 risks threatening economy: BMO

Forget Vancouver’s high-priced and highly scrutinized housing market, Toronto is the trouble spot that could spark a housing correction, according to a new report.

Bank of Montreal (BMO) has identified soaring house prices in Toronto as one of three risks facing the North American economy, alongside the U.S. debt ceiling and the impact of political uncertainty in emerging markets.

Why is Toronto’s market being singled out? BMO economist Sal Guatieri says home prices in Canada's largest city are rising at a pace that is faster than household income, which threatens to leave more buyers on the sidelines. Rising interest rates, which are expected over the next couple of years, could make it worse. The number of new condos going up across the city adds to the threat.

“In Canada, accelerating home prices in Toronto … risk straining affordability further, causing a correction when interest rates normalize and the market is trying to absorb a record number of newly built condos,” Guatieri wrote.

He cited a 7.1 per cent year-over-year increase in house prices in January. For Canada as a whole, prices rose 4.3 per cent, which he called "in line with income growth."

The Toronto Real Estate Board (TREB) reported last week that house prices in the Greater Toronto Area (GTA) increased by about 9 per cent in January compared to a year earlier. The average selling price for a home in the GTA was $526,528.

Toronto’s price increase was even higher than Vancouver, the most expensive market, where the average selling price was $606,800 in January, up 3 per cent year-over-year.

The BMO report follows another warning last week from TD Bank suggesting the overall Canadian housing market overall was overvalued by about 10 per cent when measured by affordability. It was written in defence of other measures used to gauge Canada’s housing market, including the home price-to-rent ratio and the price-to-income ratio. By those measurements, Canada's housing market is said to be overvalued by as much as 60 per cent.

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

A Royal Bank report last week shows residential mortgage debt increased 4.8 per cent in Canada last year, although it was the slowest annual pace of growth since 2000.

The federal government has steadily tightened mortgage rules in recent years to discourage buyers from taking on more household debt than they can handle.

The biggest concern going forward is what happens when interest rates rise further, as noted in the BMO report.

It’s not seen as an imminent issue given that the Bank of Canada is struggling with low inflation. Some economists believe the bank could potentially lower rates if Canada's economy doesn't gain more momentum.

The benchmark interest rate has been at 1 per cent since September 2010.