House price overvaluation “is especially marked in Canada,” says a new report on the state of the world’s housing market from The Economist.
The magazine’s survey found Canadian house prices are severely overvalued when compared to rental rates, and also significantly overvalued when compared to Canadians’ earnings.
Looking at the average ratio of rental rates to house prices going back to 1975, The Economist found house prices in Canada are overvalued by 78 per cent. That makes Canada's the most overvalued of 18 housing markets surveyed by the magazine, by this measure.
But when compared to household incomes, home prices are overvalued by only about 34 per cent, the survey found.
The magazine quipped that Bank of Canada governor Mark Carney “may have shown good … timing” in jumping ship to the Bank of England when he did — implying that Carney could be in for blame if the housing market slowdown worsens.
The overvaluation numbers are slightly worse than the last time The Economist surveyed the housing market, in November of 2011. At that time, Canadian house prices were overvalued by 71 per cent compared to rents, and 29 per cent compared to incomes.
The Economist’s numbers are alarming, not least because they imply that a massive correction in house prices is headed for Canada.
But many market analysts say Canada’s situation is not as bad as the value comparisons would have it. In a report late last year, CIBC economist Benjamin Tal argued that because interest rates are so low, actual housing affordability is much better than house prices would suggest — people can afford their mortgage payments.
But that depends on interest rates staying at near-record lows.
RBC this week predicted that Canada will see an interest rate hike by the end of this year. However, as the Bank of Canada targets inflation, the country will have to see higher inflation rates before the bank makes any move on rates. And right now, inflation in Canada is well below target.