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Canada Mortgage and Housing Corp. is warning that Canada’s two largest housing markets remain “highly vulnerable” to a correction, despite recent moves by regulators and governments that have dented sales and stabilized prices.

In its latest housing market assessment report released Thursday, the federal mortgage insurer said markets in Toronto and Vancouver are overvalued and overheated and rated both regions as highly vulnerable to instability – the agency’s highest level of market warning. The agency said house prices continue to be excessive compared with market fundamentals such as personal disposable incomes and household borrowing capacity.

The report comes amid rising interest rates and policy changes that have cooled real estate markets across the country. The biggest impact has come from the new mortgage stress-test rule that took effect Jan. 1, requiring home buyers to prove they could still afford their mortgages even if interest rates were significantly higher.

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In the past year, both cities have seen home sales decline sharply, especially for detached homes, and prices have moderated. The Greater Toronto Area, for example, recorded a 27-per-cent drop in home sales in the first six months of this year compared with last year, while sales fell 25 per cent in Greater Vancouver. The MLS benchmark home price fell 4.76 per cent in the GTA in June compared with a year earlier, while the benchmark price was up 9.6 per cent in Greater Vancouver in June on a year-over-year basis. Vancouver’s price gains slowed to 4.1 per cent in the first six months of the year.

Despite slowing sales, CMHC chief economist Bob Dugan said the warnings about vulnerability have not been adjusted in Toronto and Vancouver because the agency needs long-term evidence that the market is changing.

“Prices can fluctuate and be up one quarter, down the next, and if every quarter we’re reacting to that and changing our message, it becomes a little more confusing what the overall assessment of the market might be,” he said.

CMHC’s assessment of risk in Toronto’s market has been unchanged since October, 2016, while Vancouver’s assessment has been unchanged since July, 2017.

Both cities are also assessed as having “moderate” overheating and price acceleration, contributing to the assessment they are highly vulnerable to instability. Hamilton and Victoria are the only other major metropolitan markets in Canada to have a high vulnerability rating.

Real estate agents, however, say it is hard to reconcile warning that markets are overheated and vulnerable to instability after they have seen such slow sales in the past year.

John Pasalis, president of Realosophy Realty Inc. in Toronto, said prices in the region are probably still overvalued on a fundamental level compared with average incomes, but most segments of the market are not overheated and prices are not accelerating.

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“Prices have been flat for a year, so I don’t see signs of acceleration,” he said. “This is not necessarily consistent with what’s the ground, this whole price acceleration and it’s overheated. This is not what people are seeing – they are seeing things cooling.”

Scott Ingram, a Century 21 real estate agent in Toronto, said CMHC is “erring on the side of caution” in its conclusion that the city is overheating and prices are accelerating. Both could be future risks, but are not currently occurring, he said.

“It seems like they’re likening the real estate market to a fire where the flames are all extinguished but the fire is still smouldering under the surface and the fire could come back to life at any time in the next three years. [It is] ultraconservative,” he said.

Benjamin Tal, deputy chief economist at CIBC World Markets Inc., said he is not surprised CMHC considers the GTA vulnerable because housing is overvalued. He said condominium prices are still rising in Toronto as well, so some segments are still hot.

But he said overvaluation doesn’t mean prices are going to fall. Home prices are shaped not only by fundamentals like household incomes, but also by supply factors such as affordable low-priced housing options, he said.

“Using the term overpriced does not mean that it must go down. … Using that framework, the city can remain ‘overpriced’ for a long period of time,” he said.

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CMHC’s report also said it has seen rapid growth in house prices in some neighbourhoods in Montreal, warning the city’s vulnerability rating could be raised in the future if the trends continue.

The agency said Canada’s housing market over all remained “highly vulnerable” for the eighth consecutive quarter because of overvaluation and price acceleration in Toronto, Vancouver, Victoria and Hamilton.

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