UBC Centre for Urban Economics and Real Estate:
The severe downturn in US housing markets is triggering concerns that markets in Canada will also contract dramatically. Despite more conservative lending practices in Canada that prevented the speculative excess seen in some US markets, we find that the housing stock in many major Canadian cities is substantially overpriced.
There are parallels between the path of house prices in Canadian and US markets. The US housing boom began in 1997 and peaked in mid 2006 with house prices rising 132 percent. Canadian prices began their run‐up in 2001 and have only in 2008 begun to slow. Housing affordability is a severe problem in some Canadian cities, limiting the ability of markets to continue to rise. Finally, declining sales and weakening prices are signs that the decade long boom in Canadian markets is over.
Are Canadian housing markets likely to follow those in the US down? This report helps to answer this question by analyzing whether Canadian house prices are overvalued. We ask: how do current house prices in nine major Canadian cities compare to their equilibrium or balanced market levels?
We define the equilibrium housing price in a city from the relationship between house rents and prices in that city. Formally, we say a housing market is in equilibrium when the ratio of house rents to prices equals the cost of capital for owning a house, which is the sum of the mortgage rate and out of pocket costs, then minus the expected rate of long‐run house price appreciation. Our approach is not the only way to test for equilibrium in housing markets; other methodologies include looking at historic rates of price growth, comparing price growth with income and population growth, or measuring price to income ratios.
We find that:
- Only in Toronto are prices in balance with rents
- In Halifax, Montreal, Ottawa, Regina, and Winnipeg prices would need to drop by at least 25 percent from their level in the second quarter of 2008 to be in balance.
- Prices declines in Calgary and Vancouver will be more modest: 7 to 11 percent
- In Edmonton prices are now below their equilibrium level by 8 percent