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The downtown Vancouver skyline.DARRYL DYCK/The Globe and Mail

Hot markets in Vancouver and Toronto are causing home prices to rise in nearby areas, prompting Canada's housing agency to issue a red alert about the country's real estate sector as a whole.

Canada Mortgage and Housing Corp. chief executive officer Evan Siddall said in an interview the agency's "red" warning means that there is a strong risk of problems on the horizon. Ottawa uses CMHC analyses to guide its policies for the housing industry.

"We're observing the spillover effects in the central markets of Vancouver and Toronto, affecting nearby markets. In Toronto, it's affecting Hamilton and Oshawa. Outside of Vancouver, it's places like Richmond and the Fraser Valley. You're seeing price acceleration," Mr. Siddall said. "At the nationwide level, the evidence of problematic conditions has become high – that's what red means. It's not predicting a crash."

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The problems include not just rising prices, but overvaluation.

CMHC will boost the risk rating in its overall assessment of the country's residential market to "strong" from "moderate" when it issues a new report on Oct. 26.

Mr. Siddall first disclosed CMHC's decision to issue the red alert in an opinion column on Monday in The Globe and Mail. CMHC's new warning has been months in the making. The agency rates 15 metropolitan markets as weak (green), moderate (yellow) or strong (red) based on risk signals.

Earlier this month, federal Finance Minister Bill Morneau announced measures to tighten mortgage rules, such as a new standard for gauging whether buyers can handle an eventual increase in interest rates.

Those changes took effect on Monday.

"If people can just save a bit more money and have a bit more equity in their homes, that would be safer," Mr. Siddall said. "A 5-per-cent down payment means you don't have a lot of cushion on the downside."

The federal government's decision to tighten lending rules will reduce demand from prospective home buyers, the real estate industry argues. "The government has taken away the punch bowl, the party is coming to an end," Vancouver real estate agent Steve Saretsky said in an e-mail to his clients.

Matthieu Arseneau, senior economist at National Bank Financial Inc., said the authorized lending limit for certain types of insured mortgages (fixed five-year term, for example) could fall by 17 per cent because of Ottawa's measures. He estimates that 7 per cent of home sales could be affected by Ottawa's efforts to curb risk in the housing market.

Mr. Siddall said he understands the concerns that some buyers can no longer take out mortgages as large as in the past, but such consumers will benefit in the long term from Ottawa's "stress test" that uses the Bank of Canada's higher posted interest rate to determine who qualifies for an insured mortgage.

"We're not spiking the punch bowl," Mr. Siddall said. "If we're making it easy for people to borrow money to buy a house, we're creating demand, which is only pushing the price higher."

Ottawa also closed tax loopholes used by some foreign buyers, effective on Oct. 3.

In July, CMHC increased its warning for Canada as a whole from weak to moderate. The Vancouver region has come under increased scrutiny this year.

The federal Crown corporation changed its quarterly risk rating on the Vancouver area to moderate in April and to strong in July.

CMHC also saw Calgary, Saskatoon, Regina and Toronto as housing markets that showed strong signs in July of problems looming.

"The housing industry continues to do the heavy lifting for the Canadian economy. I worry that policy makers are looking at what they are doing in isolation. We could end up doing more harm to the most important industry in the country," said Phil Soper, chief executive officer of real estate firm Royal LePage.

Some industry observers have been sounding the alarm for more than a year about what they view as overheated housing markets in Canada, and the federal agency is the latest to do so. "CMHC is an important voice. Maybe they are late, but is it that important that they are late? No," Mr. Soper said. "Where CMHC could do more or be helpful is the collection of information such as the influence of non-Canadian and non-resident home buyers."

B.C. Finance Minister Mike de Jong said "others will have to decide" whether CMHC's warning shows his government took too long to cool the housing market in British Columbia. Mr. de Jong said B.C. enacted a tax on foreign buyers after it began collecting data that showed they were involved in about one in every 10 Metro Vancouver home sales earlier this summer.

"I think the average citizen would say, 'Well, why the hell weren't you collecting this basic data for some time?' Fair enough, we weren't. It stopped in the 1990s some time," he told The Globe and Mail's editorial board on Monday. "We proceeded to begin collecting that data and when we were in the position to make decisions on the basis of at least a subset of information that was reliable, we did so."

The B.C. government announced a 15-per-cent tax on purchases by foreign home buyers in the Vancouver area, effective Aug. 2.

"Low affordability and the likely reduction of international capital inflows in the wake of the transfer tax finally end the steep appreciation that started in 2013," economic forecaster Moody's Analytics said in a new report, predicting that prices will fall next year for detached houses in the Vancouver region.

Moody's, which uses data from the Brookfield RPS House Price Indices, envisages a price drop in 2017 of less than 3 per cent for detached houses but cautions a steeper decline is possible.

Rating agency DBRS Ltd. said low interest rates, steady immigration and limited housing supply are among the numerous influences over real estate prices, and there aren't any simple solutions to improve affordability. "The stream of new government measures introduced this year are expected to contribute to cooling down the market and reducing risks to taxpayers, lenders, investors and to households themselves, although they might be detrimental to economic expansion," DBRS cautions.

With a report from Mike Hager

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