TORONTO - Canadian house prices are due for a 10 per cent correction — and likely even more in overheated Toronto and Vancouver — but will likely avoid a U.S.-style collapse, according to a Scotiabank report.
Economists from the chartered bank said in a report Wednesday that average Canadian house prices will likely experience a cumulative 10 per cent drop in the next two to three years as demand softens.
Toronto and Vancouver, where average prices are well above the national average, could suffer an even steeper decline as oversupply and affordability issues turn the cities into a buyer's market.
"Record prices combined with incremental regulatory tightening are reducing affordability and the housing market's earlier momentum," economists Aron Gampel, Adrienne Warren and Mary Webb report.
"Pent-up demand has been effectively exhausted after a decade-long housing boom, with Canadian home ownership at record levels."
The housing market has been particularly busy in the years since the 2008-2009 recession — after the Bank of Canada moved to lower interest rates to ultra low levels to stimulate domestic spending. And the fragility of the global economic recovery has pressured the central bank to keep rates at a stimulative one per cent.
Low lending rates have also encouraged many buyers to find a home before they rise, leading to bidding wars, higher home prices and warnings that some homeowners may find it difficult to service their debts when interest rates inevitably rise.
However, the Scotiabank (TSX:BNS) economists don't believe Canada is at the same precipice the U.S. faced in 2007 prior to the subprime mortgage debacle, although they warn the "downside risks" are increasing.
They note that despite record household debt at 152 per cent of disposable income, the other metrics of homeowner finances remain in safe territory. Homeowner equity in their real estate holdings averages 67 per cent, compared to 41 per cent in the United States, and mortgage delinquency rates are low and falling.
The overall housing stock is not notably overbuilt, they add, with the inventory of unsold homes above the long-term average, but showing signs of levelling off to below the peaks of the early 1990s.
The bank predicts housing starts will slow to more a sustainable level of 185,000 to 190,000 a year, from the current average of close to 220,000.
The Scotiabank projection is the latest of several that have suggested prices have climbed too far. Some, such as Capital Economics, have called for a correction as big as 25 per cent.
In June, Finance Minister Jim Flaherty cited Toronto and Vancouver's hot condo market in his reasoning for a further tightening rules on government-insured mortgages by reducing the maximum amortization period to 25 years from 30.
In the past four years ago, Ottawa has taken the amortization period from 40 years to 25, effectively raising the monthly mortgage payment on an average-priced home with a minimum down payment by $377, the economists estimate.
The Scotiabank economists also single out Toronto and Vancouver as most vulnerable to a steep correction, noting that markets remain balanced and conditions favourable in most other markets.
In Toronto, "a rising inventory, fuelled in part by strong investor demand, represents additional downside risk," they write. In Vancouver, "housing demand has fallen 20 per cent below its long-term trend ... (and) elevated prices are only now beginning to adjust lower. In addition, the Vancouver housing market, particularly the luxury segment, is vulnerable to shifts in offshore investor sentiment."
The economists say the most likely outcome is that the housing market will adjust as it has in the past, when booms in the 1970s and 1980s were followed by flat or declining prices that lasted almost a decade.
However, they warn that there are risks of a sharper drop should the weak global economy impact job creation and investment in Canada.
A sharp correction would likely also have a significant impact on the economy, economists say, given that homeowners will be poorer and demand for new residential construction would fall.
The report points out that during the boom of the past decade, the construction industry has generated about 425,000 additional jobs, close to one in five of all new jobs created by the economy.