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A house for sale in Toronto on March 15, 2013.

Fred Lum/ The Globe and Mail

Housing prices in Canada have been relatively flat so far this year but there's a "downside risk" going forward, particularly in the country's largest city, according to a Scotiabank report issued Friday.

"Toronto's housing market is correcting in the wake of affordability pressures, inventory build, changes to mortgage insurance rules and more cautious lending policies," writes Scotiabank economist Adrienne Warren.

"Sales and construction have already shifted notably lower, and prices are beginning to level out. We expect this adjustment process to continue into mid-decade, with downside risk to prices, particularly in the condominium market where supply additions are expected to outpace underlying demand."

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It said a tight supply of single-family homes in the area has supported overall home price averages. It also notes that, while there's a lag, prices tend to fall after sales drop off and the supply of unsold properties rises.

The report says the rebalancing will be manageable if new construction slows, population in the Greater Toronto Area continues to grow and interest rates remain low.

The Toronto condo market has been watched closely by policy makers in the federal government and Bank of Canada, as well as private-sector economists. While it's generally agreed that Toronto home prices are overvalued, there's a range of estimates about how much they will likely come down.

Finance Minister Jim Flaherty introduced stricter mortgage rules last summer to offset persistently low interest rates that have simulated borrowing and pushed up real-estate prices in some markets – particularly in Toronto and Vancouver.

The Scotiabank report says the new rules, repeated warnings over high household debt levels and moderate growth in employment and income, have resulted in a 10-per-cent drop in resales of previously occupied homes in Toronto.

"Sales of new homes have also fallen sharply, reflecting increased competition from the resale market as well as fewer high-rise launches as developers delay or scale back projects in the wake of increased inventory and moderating price growth," Warren writes.

"Meanwhile, lower expected returns are tempering investor activity. Roughly 50 per cent of pre-construction condominium purchases in recent years are estimated to have been by investors."

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Housing starts in the Toronto area totalled just 28,900 units on an annualized basis in the first four months of 2013, down about 40 per cent from last year, the report says.

Internationally, the "Global Real Estate Trends" report finds Canada and Australia at the mid-point between countries where prices have been rising (such as Colombia, the United States and Chile) where they have fallen (Spain, Italy and Ireland, among other).

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