Thursday, December 22, 2011

House Prices in Canada

What’s likely to happen to house prices in Canada? Are house prices more out of whack with fundamentals in British Columbia than in Ontario or Alberta? And what would the consequences be for the economy if house prices fell?

The IMF’s economic outlook for Canada has an extensive discussion of prospects for the Canadian housing market. IMF staff noted that “the [house] price-to-rent and [house] price-to-income ratios are 29 percent and 20 percent above their averages for the last decade, respectively”. My earlier post compares Canadian ratios to those in the U.S. and Europe.

IMF staff said that “while there are structural factors that can explain increases in such ratios, their elevated level and other empirical evidence suggest that house prices may be higher than justified by underlying fundamentals, at least in some provinces—staff estimates indicate an average price overvaluation of around 10 percent, with significant regional differences.”

A companion paper estimates “house prices in 2011 to be above the levels consistent with the current levels of fundamentals in British Columbia, with some signs of overvaluation also in Ontario, and to a lesser degree, in Quebec. By contrast, the estimated models suggest house prices to be mildly undervalued in Alberta.” Averaging these estimates (with weights based on provincial GDP levels), the paper suggests “that house prices in Canada are on average ten percent above the level consistent with current fundamentals.”

The companion paper also studied “the impact of a potential correction in house prices on consumption through household wealth effects.” The paper’s authors concluded that the “empirical estimates suggest that a ten percent decline in house prices would lead to a 1¼ percent decline in private consumption.”

The full report can be found here. In it, IMF staff noted that “to ensure the long-term stability of housing markets” the Canadian government has “increased public awareness of the risks and … tightened mortgage insurance standards several times since 2008.”