Canadian Housing Market Overvalued by 20 Percent, IMF Data Suggests

Canadian Housing MarketA report from the International Monetary Fund suggests that the Canadian housing market, one seen by many to be overheated, is overvalued by about 20 percent.

The IMF’s report covers the whole of Canada, and overvaluation figures tend to vary based on region and regional variables; there are some parts of the country where overvaluation is as low as 7 percent. “Canada’s housing market rebounded in 2014, fuelled by low and declining interest rates although there are some welcome signs of cooling especially in overheated markets,” noted the IMF in its report, which came soon after a Fitch Ratings report earlier in the week that included some interesting insights.

Fitch, like the IMF, sees the Canadian housing space overvalued by as much as 20 percent, due chiefly to precipitous drops in fuel prices. The IMF had a similar assessment, stating that lower oil prices would be a headwind against financial growth in Canada. Several organizations and individuals have repeatedly expressed concern that the extreme bullishness in the Canadian housing market may be the catalyst for a U.S.-style housing bubble, but the IMF is one of many that expect any market crash to come in the form of a “soft landing,” in business parlance.

At the moment, interest rates are also retreating significantly in Canada. Most financial institutions’ prime rates have been dropped to 2.85 percent, as the Bank of Canada last week made a surprise decision to reduce its overnight interest rate from 1 percent to 0.75 percent.

There are a few financial experts who believe that there may be more cuts forthcoming to the overnight rate, and that banks may not pass on the savings to customers by way of a lower prime rate. These rate decreases may be discussed when the Canadian central bank holds its March meeting. At major banks, five-year fixed-rate mortgages have hit levels of as low as 2.84 percent.

Interestingly, the IMF noted that it was its guidance that influenced Canada to make use of monetary policy as a tool to counter the potentially disastrous effect of lower oil prices. “Domestic vulnerabilities in housing markets and household sector remain elevated, but contained from a financial stability perspective,” read its report. The IMF added that Canadian policymakers should be cognizant of the effect of policy changes vis-à-vis home prices and household debt.

Another key takeaway on the IMF report was a part that had pertained mainly to how the Canadian government is directly exposed to the real estate market. The organization was in approval of confirmed or planned moves from the Canada Mortgage and Housing Corporation (CMHC), which include gradually reducing the amount of consumer default that it is willing to insure. CMHC also had a plan wherein financial institutions have their own deductible in case of default.

“Directors welcomed the authorities’ recent initiatives to limit the government’s exposure to the housing sector,” said the IMF in its report. “They encouraged further action gradually to ensure appropriate risk retention by the private sector, in the longer run, to re-examine the dimensions of extensive government-backed mortgage insurance.”