Fitch Ratings says that the Canadian housing market could see a soft landing in the years ahead, despite being an estimated 21% overvalued at present levels.
The rating agency published a new report Tuesday, which indicates that the Canadian housing market is currently about 21% overvalued, in real terms. It notes that national home prices have rapidly increased since 2001, rising over 130%, outpacing income growth over the same period by over 80%. British Columbia and Quebec are most overvalued among the big provinces at about 26%, it says; with Ontario overvalued by around 21%, and Alberta 15% overvalued.
The Canadian economy has a high level of exposure to increasing home prices, notes Fitch director, Stefan Hilts. “Canadian buyers reaching for homes at high prices are pushing household leverage to record levels, leaving borrowers susceptible to interest rate shocks,” Hilts said. “With a high level of employment and individual net worth tied to the value of the housing stock, a housing downturn could have serious consequences for the overall economy in Canada.”
That said, Fitch suggests that, even in a down scenario, nominal home prices in Canada should fall by no more than 10% over the next five years, after taking into account momentum and inflation. And, it says that there are several factors — such as prudent lending practices, strong employment levels, rising incomes and government willingness to address the issue — that could point to an even softer landing.
“The Canadian government has been very proactive with numerous policies specifically targeting a soft landing, which augurs for nominal home prices simply flattening out or seeing relatively small reductions,” said Hilts.
Still, Fitch says it remains cautious. “Prices continue to be significantly above long-term, sustainable levels, and borrower leverage presents continued risk,” it says in the report. “With borrowers at record levels of household debt, there is a high sensitivity to interest rates, which remain at record low levels.”
As interest rates rise over the next few years, there is a risk of payment shocks for some borrowers, it notes. “Borrowers with high debt service ratios and high leverage could be at significantly increased risk in this scenario, and higher borrowing costs could increase mortgage costs and depress home values,” it warns.