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A home sold in Vancouver. (DARRYL DYCK FOR THE GLOBE AND MAIL)
A home sold in Vancouver. (DARRYL DYCK FOR THE GLOBE AND MAIL)

Why Fitch is sticking to its 20% Canadian home price overvaluation Add to ...

The Globe’s Real Estate Beat offers news and analysis on the Canadian housing market from real estate reporter Tara Perkins. Read more on The Globe’s housing page and follow Tara on Twitter @TaraPerkins.

Fitch Ratings reiterated its view this week that Canadian home prices are about 20 per cent too high.

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The rating agency first made that statement more than a year ago, but it says its estimate still stands.

In its latest report, Fitch said that it thinks high household debt levels (relative to disposable income) have made the Canadian housing market more susceptible to stresses like unemployment or interest rate hikes. It added that policy makers might have to take more steps in the short term to ensure a so-called “soft landing” in the housing market.

A soft landing would see the market slowly lose steam, which would take some of the froth out without a crash. On Wednesday, the Bank of Canada said a soft landing remains the most likely scenario for the housing market, but that near record-high house prices and debt levels do leave households vulnerable to shocks. “The recent rebound in housing activity is most likely only compensating for weakness in earlier months, but it could signal the beginning of a more persistent rise in housing activity and price pressures,” the central bank said.

I spoke to Vanessa Purwin, a senior director at Fitch, to find out more about the agency’s thoughts on the Canadian market.

How did you arrive at the 20-per-cent overvaluation?

The 20 per cent is derived from our sustainable home price model for the Canadian market, where we compare changes in home prices historically to changes in five major macroeconomic indicators that we consider to drive the housing market, which are income, employment, interest rates, housing supply and population growth.

Your piece talked about a lack of supply in major markets, and I assume you were talking about cities like Toronto. We talk about Canada over all but there are some pretty significant regional disparities. Are there some markets that you’re looking at more than others?

We are focused on the four largest provinces: Ontario, British Columbia, Quebec, Alberta. The lack of supply is most applicable in Greater Toronto and Greater Vancouver. I guess the potential for concern is that as you move further out from those big cities, but see rises in house prices, that the lack of supply won’t be there long term to help support house price values. So potentially more rural, less urban, markets may me more susceptible to a decline in prices.

How does Canada compare to other countries?

In the U.S., we’ve already taken significant house price declines. We still see the market – given the recent increases in prices – around 10-per-cent overvalued.

I don’t think we’re the first to draw connections between the Canadian market and the Australian market. They’ve similarly benefited from positive home price growth, even throughout the financial crisis. So where we are with Canada at about 20-per-cent overvaluation for the country, and up to maybe 25 or 26 per cent for provinces like British Columbia and Ontario, we have similar market value decline projections for the Australian market in the range of 25 to 30 per cent. And it’s a similar story, you’ve got low interest rates that have supported affordability, again limited supply in the big cities like Melbourne, Sydney, Perth, and also you’ve had in that market population growth that’s been above historical averages that’s also supporting house prices on the demand side.

Are you warning the Canadian government about house prices, and do you think it would be wise to do something sooner rather than later?

It’s not necessarily a warning, it’s more of an observation. I think the government has been successful in slowing down growth in home prices with the measures they’ve taken to date, but we do still see that prices are continuing to rise. So depending on how we see the changes that have already been made play out over the next couple months, they may need to take more action. But they’ve done a good job of it so far and they’d really be in the best position to decide what the most appropriate types of actions might be.

Does what you’re saying imply that house prices have to come down by 20 per cent from where they’re at to be at a healthy level, or alternatively could there be growth in the other five factors you mentioned?

Yes, we’re not predicting that in the next year or two years that house prices are going to fall 20 per cent. We see, compared to historical macro fundamentals, that there’s 20-per-cent overvaluation, but to your point if incomes start to rise at faster rates or we see greater decreases in unemployment or see significant growth in the population that would support further demand, that these are all things that would bring values closer to sustainable levels without them having to come down.

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