Home prices running risk of eventual slowdown

Canadian housing prices are likely to soften as the current real estate boom gets long in the tooth and price increases creep above historical norms, according to a Scotia Economics report.

The report said national housing market fundamentals remain strong -- with low unemployment, high immigration, little evidence of overbuilding or speculation, and only a slight exposure to subprime lending.

"Yet there is little doubt that current trends are unsustainable," the report states. "The current housing boom is now the longest of the post-war era [going on nine years], and has seen one of the largest cumulative real price gains [more than 60 per cent]."

The report said almost every Canadian city surveyed has house prices that are higher than they would be if price increases this year followed the historical averages recorded between 1980 and 2006.

The average deviation from the historical norm was eight per cent, ranging from minus one per cent in St. John's to 25 per cent in Edmonton.

Vancouver had the highest average house price during the first half of 2007 -- $570,000, which is 13 per cent above its historical norm.

"There is growing evidence of overvaluation in home prices in some parts of the country -- a precursor to a period of softening conditions," the report said.

Scotia Economics senior economist Adrienne Warren said housing affordability is becoming increasingly stretched for many would-be buyers after nearly a decade of rising prices.

"The further domestic home prices climb above underlying economic fundamentals, the greater the risk of an eventual correction," she said.

Warren doubts house prices will actually fall in the near future, but expects price growth will drop significantly from current levels. She expects national house price increases of 10 per cent this year will fall to between five and 10 per cent in 2008 and below five per cent in 2009.

Warren said Vancouver's 13-per-cent deviation above its historical house price norm this year does not indicate a "frothy" market that's ready to collapse.

"It has just been pushed up by continued strong demand and a fairly tight supply, but it does not indicate a lot of speculative activity," she said.

Warren noted Toronto experienced a major house price correction after posting a 33-per-cent deviation rate above its historical house price norm during a previous housing market peak in 1989.

She said higher interest rates would accelerate a national housing market correction but doubts that will happen, feeling a bigger risk is more likely to come from a U.S. economic downturn affecting the Canadian economy.

The report said Canada ranks relatively low in the degree of house price overvaluation, compared with other major developed nations that have also experienced housing booms in the past decade.

It said average real home prices in the U.S. carried a 14-per-cent premium in 2005 but values have since slipped amid growing supply and weakening demand.

(prepared by Bruce Constaneau/Vancouver Sun)