Toronto-Dominion Bank chief economist Craig Alexander said in an analysis that if the overvaluation were unwound rapidly, the market correction would be three times the magnitude of the housing market correction of the early 1990s.
Alexander said it is more likely that there will be a gradual decline in sales and prices over the next several years unless there is a sharp rise in joblessness or interest rates. He warned against complacency, however.
“We need to acknowledge that a significant imbalance has developed and it poses a clear and present danger to Canada’s medium-term economic outlook,” he wrote. “It also suggests that further actions to constrain lending growth may be prudent.”
At greatest risk is Vancouver’s real estate market, a magnet for foreign buyers, along with the Toronto condo market, and the broad housing markets in Quebec City and Montreal, he said.
“Nevertheless, beyond selected cities, it is natural to assume that it will be a shock to all real estate markets when interest rates eventually rise from their prevailing exceedingly low levels,” he said.
Parallel with the real estate valuations is elevated household indebtedness. The ratio of debt to personal disposable income declined in the fourth quarter of 2011 to 150.6 percent from 151.9 percent in the third, but Alexander said this was due to a spike in unincorporated business and farm income that will probably prove to be temporary.
In fact, he forecast that by late 2013 the ratio will reach the 160 percent peak seen in the United States and Britain before their real estate corrections.
Alexander said the Bank of Canada, which has repeatedly voiced concern over housing prices and household debt, is in a bind because if it raises rates while the U.S. Federal Reserve holds rates steady, that would boost the Canadian dollar further and slow growth.
A majority of forecasters polled by Reuters last month predicted that the federal government would tighten mortgage rules this year. Alexander urged authorities to take a gradualist approach in any tightening.