Hot home prices expected to cool

Canadian home prices are running hotter than they should be and, in some parts of the country, overvaluation will lead to slower price gains, a report predicted Thursday.

The risk of an eventual softening in the market comes as tight supply and demand conditions have hoisted home prices well above their long-term trend, the Bank of Nova Scotia said.

Scotia is predicting a cooling, not a collapse. Fundamentals remain solid in Canada because of low unemployment, high immigration and tight apartment vacancies. Speculative buying is rare and subprime mortgage loans account for just 5 per cent of the market in Canada – much lower than the 20-per-cent market share in the U.S.

Years of relentless house prices increases, however, mean affordability is waning just as risks to the economy mount.

“There is little doubt that current trends are unsustainable,” said Adrienne Warren, the bank's senior economist and author of the report.

“Affordability is becoming increasingly stretched for many would be buyers after almost a decade of rising home prices. More recently, economic risks have increased in the wake of the intensifying financial market turmoil stemming from the U.S. subprime mortgage problems.”

She examined home prices in 15 cities across the country. All but St. John's showed current inflation-adjusted price levels were above their long-term trend. The average deviation across the country was about 8 per cent, but with wide regional variations. In Ottawa, it was just 1 per cent while in Edmonton it was 25 per cent.

Ms. Warren stresses that Canada ranks relatively low in the degree of overvaluation relative to other developed nations.

Still, she's not the only one raising the red flag. Canada's housing affordability saw “one of the largest and most broadly based quarterly deteriorations since the mid-1990s,” said Derek Holt, assistant chief economist at the Royal Bank of Canada, in a report yesterday.

A standard two-storey home now eats up about 46 per cent of pre-tax household income, with all types of homes experiencing a slide in affordability.

Companies are already feeling the pinch. Toronto-based Xceed Mortgage Corp. on Thursday froze its dividend payments as turmoil in the U.S. subprime market sparked a drop in quarterly profit. “For the duration of this period, it is going to be a difficult and challenging time for our industry, Xceed, and our investors,” warned Ivan Wahl, chairman and chief executive officer.

It's also spilling into lumber sales. Weyerhaeuser Co., one of the world's largest of lumber and paper companies, said this week it may close plants and cut back on business because of the U.S. slowdown.

The Canadian economy is increasingly vulnerable to any decrease in housing prices because home-ownership rate is sitting at the highest level on record, national census data showed yesterday.

For now, prices continue to rise at a healthy clip, though that pace is slowing. National prices were, on average, 7.7 per cent higher in July from a year ago though the rate of increases has been decelerating for almost a year.

(prepared by Tavia Grant/Globe and Mail)