Housing prices in Canada - is the market overpriced?

The year over year housing price index in Canada has been rising 2.5% as reported by Statistics Canada. This is the Canada wide number , but regionally some areas have been rising between 5 % and 6%.

The Bank of Canada uses the ratio of disposable income to the house price index to determine housing affordability. The ratio in 1990 was 3 times,  and in 2010 is 5 times disposable income. This suggests that  house prices are higher than justified by the underlying fundamentals. The overall average overvaluation is estimated at 10% with significant regional differences.

Bank economists expect house prices to shrink over 2012, which could lead to a negative feed back loop,  where the drop in house prices reduces individuals net worth which results in further cuts in spending affecting overall GDP.

In the past week three major Canadian banks have reduced their closed mortgage rates to 2.99%, the lowest rate in Canadian history. If interest rates return to more normal levels this could in turn lead to a further 10% to 15% drop in house prices due to affordability. This would lead to a drop in construction activity and declining jobs in the construction sector.

Given all these factors house prices will not be going up any time soon, and could be in for a 15% decline in 2012 along with a further decline in the GDP due to the drop in construction activity.


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