Recent Economist Study States Canadian Real Estate Overvalued. Rents and Incomes do not Support Prices. Will Home Prices in Canada Start to Fall?

A recent study conducted by the Economist indicates that housing prices in Canada are overvalued by 29% according to historical metrics that compare income levels to home prices. More astoundingly, according to measures that utilize current rental rates, the study suggests that property may be overvalued by 71%! This same situation is true in Belgium, France, Australia, New Zealand, Sweden, Spain, the Netherlands, and Britain. American real estate, having already undergone a massive correction, is undervalued by 8 to 22% according to the Economist study.

This raises two questions according to the Economist.

1) Are American prices set to rebound?

"Prices may have reached a floor, but this is no guarantee of an imminent bounce. In Britain and Sweden in the mid-1990s, prices undershot fair value by around 35%. Prices in Britain did not really start to rise for almost four years after they bottomed. Some 4m foreclosed homes could come onto America’s market, which may hold down prices." (The Economist).

2) Are overvalued markets likely to experience steep price declines?

"Some economists reject our measures of overvaluation, arguing that lower interest rates justify higher prices because buyers can take out bigger mortgages. There is some truth in this, but interest rates will not always be so low. The recent jump in bond yields in some euro-area countries has raised mortgage rates for new borrowers. And low rates need to be balanced against the fact that tighter credit conditions make it harder for home buyers to get mortgages... Another popular argument used to justify sky-high prices in countries such as Australia and Canada is that a rising population pushes up demand. But this should raise both prices and rents, leaving their ratios unchanged. Prices do not necessarily need to drop sharply to return to fair value. Adjustment could come through higher rents and wages. With low inflation, however, it could take a decade or more before price ratios return to their long-run average in some countries." (The Economist).