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Canada’s housing market overvalued by 10%, Toronto-Dominion Bank study finds

Posted on Feb 13, 2014 in Mortgage Market Updates and News

Michael Babad
The Globe and Mail

Housing market measures

Deutsche Bank puts it at 60 per cent, others in the area of 30 per cent. But Toronto-Dominion Bank says Canada’s housing market is overvalued by just 10 per cent, based on a fairer measure.

“The ongoing resilience of home prices in Canada continues to fuel considerable debate about the extent of an overvaluation in the marketplace,” TD economist Diana Petramala said in a new report today.

“The challenge is that the estimation of overvaluation depends on what ratio you look at.”

Deutsche Bank, of course, famously put Canada at the top of the list when it comes to the world’s frothiest housing markets, basing its reading of 60-per-cent overvaluation by using two measures, the ratios of house prices to rent and prices to income, compared to their averages over time.

The Organization for Economic Co-operation and Development put Canada near the top, as did The Economist.

The price-to-rent ratio pegs the level at 60 per cent, Ms. Petramala said, but is “skewed” by rent controls, and thus it’s hard to determine whether the prices are too high or if the rents are too low.

The price-to-income ratio puts overvaluation at up to 30 per cent, she added, but that really depends on what you consider income.

“A more encompassing definition of income, including government transfers and investment income, suggests the housing market is only 8 per cent overvalued.”

But it’s affordability that is key, she said, and various readings don’t factor in declining interest rates over the last 20 years. A “more normal interest rate environment” suggest 25 per cent, while current rates suggest fair value.

“However, current interest rates are likely unsustainable, nor are they expected to increase to more normal levels in the near future,” Ms. Petramala said.

“Over all, given the expectations of a modest increase in interest rates, home prices are likely 10-per-cent overvalued.”

Ms. Petramala expects stable prices, on average, this year and a decline of 2 per cent in 2015-16.

TD economists have used the 10-per-cent figure before, though then revised that down. The latest study comes in the wake of reports from the likes of Deutsche Bank, the OECD and The Economist.

The International Monetary Fund, meanwhile, also said today that the Canadian market is overvalued.

The IMF estimated average Canadian prices are overvalued by some 10 per cent, Reuters reported.

Consumer debt in Canada is still high, the agency said, and “while house prices and construction growth have cooled off, high valuations and excess supply in a number of housing markets are sources of vulnerability.”

Canada’s housing market cooled rapidly after the federal government brought in another round of mortgage restrictions in the summer of 2012, though rebounded smartly as the effects wore off.

“If house prices and mortgage credit growth heat up on a more widespread and sustained basis, additional measures, such as high down payment requirements for first-time buyers, may be needed,” the IMF said.

“Over the longer term, rethinking the role of government-backed mortgage insurance may reduce the government exposure to housing sector risks and lead to a more efficient allocation of resources.”


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