Canada's housing market among most overvalued in the world: Economist magazine

Canada’s housing market is among the most overvalued in the world and “bears an unhappy resemblance” to what the U.S. housing picture looked like before the financial crisis, according to the latest data compiled by The Economist magazine.

Measured using price-to-rent and price-to-income ratios, the Economist says housing markets are at least 25 per cent overvalued in nine of the 23 economies it tracked.

When comparing the relationship between the costs of buying and renting, it cited Canada, Hong Kong and New Zealand as “the most glaring examples” of overheated markets.

“The overshoot in these economies and others bears an unhappy resemblance to the situation that prevailed in America at the height of its boom, just before the financial crisis,” the magazine states.

It’s an update to the research released at this time last year when The Economist joined a chorus of other international market watchers warning that Canada’s housing market was poised for a crash.

The Organisation for Economic Cooperation and Development (OECD) has said Canada’s market is overvalued by as much as 30 per cent when measured by the price-to-income ratio and by 60 per cent based on the price-to-rent ratio.

Canadian economists continue to downplay these repeated international warnings, but many believe the housing market is poised for a so-called “soft landing.”

TD Bank has said it believes the market it about 10 per cent overvalued. TD and other economists have criticized the home price-to-rent ratio and the price-to-income ratios as too simplistic, failing to take into account a drop in interest rates over the last two decades. Many Canadian economists also say U.S.-style housing crash can’t happen here because of more conservative lending regulations and standards.

Housing: By the numbers

While the debate continues about how much the market will drop, and when, average Canadian home sales and prices continue to increase. Sales of existing homes rose 0.8 per cent in July compared to June, the sixth consecutive monthly increase and the highest level for sales since March 2010, the Canadian Real Estate Association said in its most recent update. It said activity is up 4.7 per cent so far this year when compared to the first seven months of 2013.

Market analysts polled recently by Reuters says they expect housing prices to keep climbing for the next two or three years, which will actually increase the risk of a crash.

"(The) risk has increased due to house price increases significantly exceeding income growth and the oversupply of condos in downtown Toronto," John Andrew, professor at Queen’s University told Reuters.

The risk comes as interest rates begin to rise, which many economists expect will happen starting later next year. The Bank of Canada has kept its benchmark interest rate at 1 per cent since September 2010, as it waits for the Canadian economy to regain its footing since the last recession.

When the Bank of Canada starts to raise rates, lenders will in turn increase mortgage and other loan interest rates, which will make home ownership less affordable for many Canadians. That could slow sales, and in turn the overall housing market.

“We expect that rising interest rates and increasingly strained affordability will cool Canada’s housing market during the next year and cause home prices to decelerate substantially in 2015,” RBC economist Robert Hogue said in a recent note.

He sees “outright price declines” in 2016 or later, depending on how quickly rates rise, but a “cooling of the market, not a crash. RBC is calling for resale activity to increase 2.1 per cent this year, highly than previously forecast, but then up by only 0.9 per cent in 2015.

“Activity has been somewhat stronger than we anticipated in recent months—fuelled in large part by an easing in mortgage rates since the start of this year,” Hogue says.

Prices will increase 4.3 per cent across Canada, then “moderate” to just 1.1 per cent next year, the bank predicts.