TORONTO - Canadian home prices are likely about 10 per cent overvalued given the expectations for rising interest rates, TD Bank said in a report Monday.
However, the bank also noted that the overvaluation in markets like Toronto, Vancouver, Montreal and Ottawa is likely more significant than in others across the country.
"These markets will likely feel the pinch from modestly higher interest rates over the next two years more so than others," TD economist Diana Petramala wrote in the report.
She noted that Montreal, Quebec City and Ottawa have been flooded with an overhang of inventory of unsold condos.
"Home prices have weakened in the second half of 2013 as a result and we expect that softness to persist in 2014," Petramala said.
"Toronto is poised to follow their lead, as the number of new condos scheduled to be completed in 2014 and 2015 is elevated relative to history."
The Canadian housing market and worries about a real estate bubble have been key concerns for policy-makers for several years. Recent indicators have suggested the market may be headed for a soft landing instead of a bubble bursting, but concerns have persisted.
"Our forecast is consistent with this imbalance unwinding gradually over the next few years through a combination of moderate income growth and a modest home price correction," Petramala wrote.
"While 2014 is likely to see stable prices on average, prices are expected to edge down by two per cent in 2015-16 as the over-building challenge increasingly weighs on the market and as borrowing costs grind higher."
The Canadian Real Estate Association reported last month that sales through its multiple listings service totalled 457,893 homes for 2013, up eight-tenths of a per cent from 2012.
The national average price for homes sold in December was $389,119, up 10.4 per cent from the end of 2012. Excluding Greater Vancouver and the Toronto region, the year-over-year increase was 4.6 per cent.
The TD report noted that overvaluation can be measured in several different ways with vastly different results.
"The home price-to-rent ratio points to an overvaluation of 60 per cent. However, this measure is skewed by rent controls. It is difficult to know whether prices are too high, or if its rents that are too low," TD said.
Another indicator, the home price-to-income ratio suggested overvaluation as high as 30 per cent, but TD said that depends on how income is defined and what is included.
"Our preferred index of assessing housing overvaluation is affordability â€” the per cent of income an average household would have to devote to mortgage payments if they purchased an average priced home and took out a conventional mortgage," the report said.
"While interest rates are not likely to return to their historical norms, the current low level of interest rates is also not sustainable. Looking forward, we expect a modest increase in interest rates."