BoC joins the housing overvaluation discussion

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The Bank of Canada has developed a new model to determine the overvaluation of housing prices in Canada and has, for the first time, provided its own estimation.

“There is considerable uncertainty associated with identifying and estimating a benchmark model of house prices. Therefore, any single measure of valuation should be interpreted with caution,” the Bank of Canada wrote in its Financial System Review – a comprehensive, 53 page report released Wednesday. “In practice, two main approaches have been used, the first based on very simple indicators and the second on more elaborate econometric models of the housing market … Bank staff have developed a new model of house price determination that adds to the available estimates.”

According to the central bank, the two traditional methodologies created wide estimate ranges, due to the very different methods used to calculate valuations.

For example, TD Bank and the International Monetary Fund (IMF) both believe Canada’s house prices are overvalued by ten per cent; Fitch Ratings suggest they are overvalued by 20 per cent and The Economist believes the figure sits around 30 per cent.

The Bank’s model attempts to address this issue. According to the report:

The model is designed to address some of the problems noted above by incorporating data on house prices in 18 oECd countries from 1975 to the present.  There are 43 major house price cycles in this sample, which allows the estimation method to obtain more precise estimates of the model’s parameters. However, like other models, it suffers from a number of shortcomings . For instance, house price fluctuations in each country are determined solely by changes in demand conditions (i.e ., real, per capita disposable income and a long-term government bond yield) . The supply side is not explicitly modelled . Constant cross-country differences are captured by country-specific intercept terms, but differences that vary over time are not included.

The new model estimates house prices are overvalued by 10-30 per cent; a range that is line with several other organizations’ figures.

The BoC also produced a graph that charts housing affordability figures dating back to 1975. According to the graph, house prices in Canada have been overvalued, to some degree, since 2005.
  • Jivan Sanghera on 2014-12-10 1:59:42 PM

    While i respect what the BoC is saying here, the overvaluation is only evident once they stop selling. we were saying the same thing 2 years ago. i don't think that we will see a correction on prices in the GTA maybe just a leveling off.

  • moe on 2014-12-10 2:19:25 PM

    There is absolutely a big 20% correction that is going to take place.....

    I think it won't really get any traction until next year once rate hikes kick in.

    however who knows!!!!!!!

  • moe on 2014-12-10 2:19:25 PM

    There is absolutely a big 20% correction that is going to take place.....

    I think it won't really get any traction until next year once rate hikes kick in.

    however who knows!!!!!!!

  • Jeff on 2014-12-10 2:35:01 PM

    Canada is a huge country with many different local economies. Just like having a single monetary policy for the entire country does not work, coming out and saying that Canada's housing market is overvalued by 30% is also a mistake, especially for the Bank of Canada to come out with. The matter is a regional one, not national.

  • Jeff on 2014-12-10 2:35:53 PM

    Canada is a huge country with many different local economies. Just like having a single monetary policy for the entire country does not work, coming out and saying that Canada's housing market is overvalued by 30% is also a mistake, especially for the Bank of Canada to come out with. The matter is a regional one, not national.

  • Angela Wong-Liao - Invis on 2014-12-10 2:45:25 PM

    I agree with Moe, I believe an adjustment is going to happen when interest rates start increasing, which according to current predictions from economists, the rate hike will be more likely in fall 2015.

  • Andre on 2014-12-10 2:48:35 PM

    Now I understand why we pay the economists at BOC the huge bucks.
    They decide that the range of overvaluation, 10%-30%,creates too much uncertainty, so they develop a new model to determine the correct %. Surprise, surprise it is 10% to 30%!

  • Len Lane on 2014-12-10 3:34:49 PM

    30% chance of rain, 10% chance of showers. Some markets possibly...as for rate hikes I have my doubts until at least 2016 europe will be along time coming back and if Russia goes into a free fall Maybe Rob McLister's article of a 1.99% five year fixed will come true.

  • Ron Butler on 2014-12-10 3:37:45 PM

    Andre......... LOL that's funny, pay people to figure out if there is 10% - 30% range and they confirm it. Our tax dollars at work! I could have given them the same estimate for a cup of coffee.

  • Paul Whatmore on 2014-12-10 4:51:35 PM

    Will there be a correction of course there will. This is not new. Do you remember A.H.O.P. or H.O.M.E.? Do you remember the all the condo's that were returned to CMHC when the mortgages mature? Having been in this business since 1977 I have seen a lot. To this day I have hanging on my front office wall a rate sheet from July 6, 1982. Can you guess what prime was? 22 3/4%. We are not going there this time and we are not going to get there suddenly. Past experiences will dictate exactly how fast we get back to even 5%. Personally I think the pain will be less than anticipated.

  • LanceH on 2014-12-10 5:58:28 PM

    I've always felt the best model, is relevant to rents. What can you get for this house if you rent it out? If you can't get 8% ROI w/ 20% down, the prices are too high. That means they're too high in TO, but not in Ajax for example. I heard recently from a banker that they LOVE Ajax, as it's the cheapest part of the GTA, and rent commensurate with the prices. There are those out there that use this model, and I'm disappointed the BOC didn't seem to consider this option.

  • Rod Doris on 2014-12-10 6:08:52 PM

    I concur with Mr. Paul Whatmore! So tired of all these useless pundits and their predictions! To the bureaucrats; nobody's listening to you either, as you don't know what you're talking about. As for the governor to the BoC, he needs to following in the footstep of his predecessor; or he'll gone with the next change of government!

  • Bucker on 2014-12-10 10:03:08 PM

    I guess everyone has a crystal ball, no correction anytime soon, in fact the Canadian market may be slightly undervalued

  • LanceH on 2014-12-11 1:01:17 PM

    @Bucker. Do you base this view on anything in particular?

  • Kuldip S Panesar Homeland Mortgage Corp. on 2014-12-11 6:50:49 PM

    The price of the commodity is determined by the demand and supply ( this is Law of Economics ) Buyers are purchasing the houses at the market price .They might have calculations of the return on their investments and take their decision after that . If supply of houses is increased over the demand the price will falls automatically , we can say the correction will take place. ....................

  • Jag Dhanoa Realtor on 2014-12-15 7:55:06 AM

    Well I agree with Kuldip's comments but also upto some extent with 8 percent ROI and 20 percent down. Rest supply and demand will continue dictating required changes....

  • Jag Dhanoa Realtor on 2014-12-15 7:56:12 AM

    Well I agree with Kuldip's comments but also upto some extent with 8 percent ROI and 20 percent down. Rest supply and demand will continue dictating required changes....

  • Juanita PringleRealtor on 2014-12-18 2:13:53 PM

    1974, 1981, 1992 the market crashed drastically, Since the City of Toronto relaxed bldg restrictions a condo and infill building boom has not stopped ...Yet. When the demand stops the prices stop but where and when ?

  • Deepak Dani on 2015-01-13 9:33:13 PM

    Prices going up since 1996. They say land is in shortage, they say 250,000 new comers come to Canada, and 100,000 to Toronto, Population will go up in Toronto by 2 Million in next 10 years, some say double by 2036, Only 20,000 units in demand to 35,000 new units being built every year, Detached Home Prices are $700,000 for new homes, Million Dollar homes at Markham and Steels sold in a day or so, so who is right? Bank of Canada, Dutch Bank or The Market Forces and Demand and Supply and Wealthy New Canadians, Baby Boomer's Children, etc etc buying more solid Investment on the earth called Real Estate!

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