Homes in Vancouver and Toronto are overvalued by 10% to 15%, compared with an average of 8% in other regions of Canada, a new TD Economics report concludes.
The report confirms Canadian homes are generally overvalued, though that overvaluation must be tempered with factors such as interest rates and rent controls.
On a strict price-to-rent comparison, that overvaluation is as high as 60%, and on a home price-to-income ratio, it is 30%.
“However, this measure is skewed by rent controls,” the report states. “It is difficult to know whether prices are too high, or if its rents that are too low. A more encompassing definition of income, including government transfers and investment income, suggests the housing market is only 8% overvalued.”
But both measures don’t take into account interest rates, which have been low for two decades, and which are unsustainable, according to the report.
“What really matters is housing affordability. The affordability index is highly sensitive to the level of interest rates. If we assume a more normal interest rate environment, the index points to a 25% overvaluation. On the other extreme, using current interest rates points to a market that is fairly valued.”
A modest rise in interest rates would mean Canadian home prices are overvalued by 10%, the report states.
The report points out that housing prices vary greatly on a regional basis. Overvaluation of homes in Vancouver, Toronto, Montreal and Ottawa are much more significant than in other parts of Canada.
The report concludes that “much of this imbalance appears to reflect frothier conditions in the larger urban centers of Toronto and Vancouver where prices are estimated to be 10% to 15% overvalued.”
