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By Tony Wong | Thu Feb 03 2011
House prices in Canada will fall over the next several years by as much as 25 per cent, creating a massive impact on the economy and possibly pushing the country into recession, says a forecast.
“The recent housing boom has resulted in the largest rises in house prices ever seen in Canada, which have been similar in magnitude to those during the recent boom in the U.S.,” said Capital Economics analyst David Madani in a report released Thursday. “Unfortunately, the subsequent falls in prices could also be just as severe as those elsewhere.”
Madani is predicting house prices will fall by a cumulative 25 per cent over the next several years, or “in the same ballpark as the recorded declines in the U.S. and other countries.”
The effects on consumer spending and housing investment could be significant and perhaps strong enough to “push the economy into another recession,” says Madani.
Financial agencies such as the Canadian Mortgage Housing Corporation, which provides mortgage loan insurance, could also be exposed to significant losses, he argues.
“We conclude that housing prices have formed a bubble and are at risk of falling substantially over the next few years.”
The market has been particularly devilish to forecast for economists because of the continuing global financial uncertainty.
Last year, the Canadian Real Estate Association modified its forecasts at least four times. After initially predicting housing prices would increase in 2011, it now says prices will fall by 1.3 per cent — far below the eye-catching 25 per cent forecast by Capital Economics.
Some economists do not see a parallel between the U.S. market and Canada.
“The price run-up in Canada has been based on strong economic fundamentals and demand from owner-occupants, whereas in the U.S., housing production was in excess of the demand that was justified by economic conditions,” said Toronto housing economist Will Dunning. “There was a large element of speculation in the U.S. that has not been present in Canada.
“If house prices are to fall, there needs to be a mechanism — an excess of supply relative to demand,” he said. “At this point, there is not an excess supply (in Canada) and it is difficult to see one materializing.”
The Capital Economics forecast is not the first to predict a bubble in the Canadian market. Gluskin Sheff & Associates chief economist David Rosenberg has also predicted a 25 per cent drop in Canadian housing prices, as has The Economist magazine.
However, the current consensus forecast by economists seems to be that Canada has achieved a “soft” landing and that prices will flatline but not go down substantially over the next several years.
As in the U.S., financial innovation and very low interest rates have allowed Canadian consumers to take on more debt, and house prices are high relative to income, says Madani.
However, consumers have remained complacent because low rates are keeping mortgage payments low.
“So what’s the problem?” Madani said. “Similar arguments were made in other countries with very low mortgage rates, including the U.S. However, this did not prevent house prices from falling in many of those countries.”
One reason is that growth in future disposable income per worker won’t close the gap between house prices and income, he says.
“Prices have risen substantially relative to income and we don’t think that’s sustainable,” said Madani.
The historical home price-to-income ratio is 3.5, but now it’s hovering around the 5.5 mark, meaning average house prices are more than five times the income of workers, he said.
And while strong net immigration and demand from baby boomers are expected to fill some of the demand for housing, we are simply building too many homes, says Madani.
Housing prices to drop 25%, forecaster predicts – Moneyville.ca.
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