How overvalued is Canada’s real estate market?

Ever since the US real estate crash in 2008, there’s been discussion about whether Canada will have a similar experience. We weathered the recession, but rising real estate prices have put Canada’s housing market on the list of one of the most overvalued markets in the world, according a recent Organisation for Economic Co-operation and Development report.

The housing market is expected to correct itself and real estate prices will drop, but it’s a question of when that will happen and whether it will be a soft landing or a hard crash.

The OECD uses two measurements to determine whether a housing market is overvalued or undervalued: The price-to-rent ratio, which measures how profitable it is to own a house, and the price-to-income ratio, which measures how affordable it is to own a house. If the ratios are above the long-term average, it means that the housing market is overvalued. Read on to find out which countries have the most overvalued housing markets and where Canada stands.

Using these indicators, OECD countries can be roughly placed into five categories:

1. Where houses appear broadly correctly valued. This category includes the Unites States, where prices have started rising again after a substantial correction; Italy, where prices are falling rapidly; Austria, where prices are rising; and Iceland, Korea and Luxembourg where prices are roughly flat.

2. Where houses appear undervalued and prices are still falling. This category includes European countries hit hard by the crisis – Greece, Ireland, Portugal, Slovenia, Slovakia and the Czech Republic – but also Japan.

3. Where houses appear undervalued but prices are rising. This category includes only Germany and Switzerland, two European countries where strong growth in household disposable income and favourable financing conditions have boosted prices (despite macro-prudential measures in Switzerland).

4. Where houses appear overvalued but prices are falling. This category is the largest as it includes many European countries where the post-crisis housing market correction is still ongoing, most notably Spain, but also the United Kingdom, Belgium, Denmark, Finland, the Netherlands and one non-European country, Australia. While price corrections in these countries are necessary, they are also concerning as they weaken households’ financial health and potentially fragilize banking sectors.

5. Where houses appear overvalued but prices are still rising. This is the case in Canada, Norway, New Zealand and, to a lesser extent, Sweden. Economies in this category are most vulnerable to the risk of a price correction – especially if borrowing costs were to rise or income growth were to slow.

Source: OECD and Josephine Lim, MSN Money

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