Why are home prices so high and when will they fall?

A recent report from the Organization for Economic Co-operation and Development that revealed Canada has the third most overvalued real estate in the developed world offered few surprises for analysts who say the market is heading for a price correction.

Many say the signs are already evident — home sales are slumping, demand is down and housing prices will likely follow suit. As for when, how far or how hard prices will fall, that still remains a guess.

Check out our interactive map tracking house prices across Canada

“The housing market is an accident waiting to happen. If there is some sort of macro shock, there’s a lot of dead air where house prices are now and where historically they should be,” said Ben Rabidoux, creator of the blog Economic Analyst, which looks into housing and mortgage trends. “And there’s a sort of saying that a market waiting for an accident to happen usually finds its accident. And that’s how I would describe it.”

The OECD report used two housing measures — the price of the average home compared to what it could be rented for and the home costs compared to the average salary.

The report found that based on rents, Canadian real estate is overvalued by as much as 60 per cent and in terms of prices to incomes, real estate is still as much as 30 per cent overvalued.

“There is no denying we’re overshooting, vis-a-vis rent, vis-a-vis income, vis-a-vis demographics. So the OECD is not adding anything here to the debate,” Benjamin Tal, CIBC deputy chief economist, told CBC News. “That’s old news.The interesting question is not that we’re overshooting, it’s what will be the corrective mechanism, namely what kind of mechanism will we see bring it back to normal.”

The reasons for the high-priced market vary. While low interest rates certainly contributed to the housing boom, Rabidoux said much has been fuelled by the availability of credit.
“It’s not like we haven’t seen periods of relatively low interest rates in the past and even in those periods we found that prices weren’t in the extreme like they are today,” Rabidoux said. “I think it’s very clear — it’s not so much the interest rate itself, it’s that really what we’ve seen in the last decade has been an unprecedented credit boom. And that’s what’s really driving these housing prices.”

Land constraints and an influx of immigration may have played some role in housing prices in Toronto and Vancouver, but Rabidoux said you would have then expected prices to have only been affected in those areas but not others.

“When you look at different metros across the country, you will find [almost] every one of them has seen a parabolic rise in house prices starting around 2003 without fail. And in my mind the most logical explanation is that this is credit driven.”