07/25/2012 05:07 EDT | Updated 09/24/2012 05:12 EDT

Canada House Prices Set To Collapse 25 Per Cent In Long Term: Capital Economics


TORONTO - If the Canadian real estate market continues to cool, house prices could see substantial declines next year and could fall by as much as 25 per cent over the long term, according to an economics report released Wednesday.

Though some economists have suggested that a tepid slowdown so far in the market suggests it is headed for a "soft landing," Capital Economics economist David Madani said he continues to believe that a more drastic drop is on its way.

"We think a housing correction over the longer-term is inevitable and still stand by our earlier view of house prices declining by 25 per cent," he said in the report.

Canada's real estate market is showing signs of cooling off following a post-recession boom sparked by a move to ultra-low interest rates. Both national home sales and the average home price were down year-over-year last month, indicators that the national market could be slowing.

The national average home price in June was $369,339, down 0.8 per cent from the same month last year. But prices increased in Calgary, remained strong in Toronto and continued to slow in Vancouver.

Home sales have dropped four per cent in the past two months and Madani said the trend is likely to continue given Ottawa's recent move to further tighten mortgage rules, by capping the maximum amortization term at 25 years.

Considering that there is usually a lag between a drop in home sales activity and prices, Madani believes a decline in home prices could come in five to nine months.

"You can certainly make the argument that on aggregate you're going to be looking at a house price correction of that magnitude," said Ben Rabidoux, an analyst and strategist with M Hanson Advisors, referring to Madani's prediction of a 25 per cent drop in prices.

"We've got house prices now that are just so completely detached from underlying fundamentals," he said.

Rabidoux said the most likely scenario is either a quick correction or a slower correction, also known as a "soft landing."

"There is just no way to duplicate the last decade in real estate prices here in Canada absent government loosening credit requirements, which I think is really off the table."

The report comes just a day after a Royal Bank of Canada report said there's no housing bubble in Toronto, one of the country's hottest markets.

The RBC report argues that the condo boom is in line with demographic need, stating that 38,000 new households come into the Greater Toronto Area each year.

The report, which aims to quell fears that scores of empty condominiums are piling up, said that faced with the task of accommodating the 38,000 new households, new housing in Toronto has nowhere to grow but up.

But Rabidoux questioned the methodology used in the RBC report.

"You can't take household formation rates from the past decade and extrapolate that into the future," he said.

"I'm just completed baffled at how they came to that number," he said, adding that with immigration driving population growth in Toronto, calculations should assume larger households.

The Capital Economics report acknowledges that house prices haven't started to fall en masse, but dismisses theories that Canada's housing market is enjoying a soft landing.

"There is always a stand-off period at the end of a housing bubble, when prospective buyers refuse to meet the prices of sellers, who refuse to drop to the asking price," said Madani.

The report warns that any stagnation in prices can be misinterpreted as a successful soft landing.

Rabidoux noted that there is a fair amount of regional variation in Canada's housing market and pointed to differences in two of the country's biggest markets as an example.

"Vancouver is quite likely going to fall right off a cliff," he said, noting that high-end home prices in Vancouver are on the decline.

"If I owned a large home in Toronto or a condo, I would have some concerns as well, but that's not to say that every city is going to experience a decline like that."

Tuesday's RBC report says the majority of condo investment properties are actually helping to fill a gap in the rental market.

It suggests that recent changes that tightened mortgage rules will push more people into the rental market.

But Madani stands firm in the view of a bubble.

"The housing bubble in Vancouver already appears to be deflating, with only Toronto defying the inevitable."

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