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The residential real estate market in Canada is strong with national prices now approximately 20% overvalued in real terms, according to a new analysis.

Government policy and an economy that successfully weathered the 2008 downturn means there has been a rapidly diminished exposure to risky mortgage products, says the report from Fitch Ratings.

Because of this strength home prices are expected to remain flat or decline modestly in 2014 despite the current overvaluation. The report also points out that except for a brief drop in 2008, home prices have risen steadily for more than a decade.

Also, a record number of housing units are currently under construction and consumer debt levels have risen to keep pace with price increases, the report says.
 
However, despite record low mortgage rates affordability is weak due to prices that have grown significantly faster than incomes and GDP over the last decade leaving price to income ratios are currently at record levels.

Fitch expects affordability to remain weak but steady in 2014, with a risk that interest rates will rise and place an additional stress on the market toward the end of the year. Because mortgage rates are expected to remain stable and prices to be flat, Fitch does not anticipate significant movements in affordability metrics.
 
‘Though with some volatility, mortgage rates have generally decreased over the past 25 years, and are currently at record low levels. Interest rate behaviour has historically been closely linked to the US, and central bank policy is expected to maintain rates at current levels through 2014, but with expectations of increases thereafter. In efforts to increase market share, Canadian banks have expanded offerings of discounts below prevailing mortgage rates,’ the report explains.

Fitch expects mortgage rates to remain mostly steady initially in 2014, though there is likely going to be more upward pressure nearing the end of the year from both US policy and Canada’s internal government.

The report also points out that with home prices rising consistently for more than a decade, mortgage performance has been very strong, with low levels of serious delinquency and defaults. However, with rising borrower leverage and the potential for softening in home price growth rates, there may be risks to performance in 2014.

With home price growth expected to slow or reverse, delinquency rates are expected to rise in 2014, though still remaining at overall low levels. Because of the relative lack of riskier mortgage products, Fitch does not expect to see significant defaults.

It explains that in response to concerns about the high growth rate in home prices, the Canadian government began to reduce support for certain riskier mortgage types and to restrict the total amount of mortgage insurance available in the market.

‘These actions are expected to contribute to a slowdown in growth in total mortgage credit outstanding, though high price levels and market demand have continued to push this number higher,’ it adds.

This article was republished with permission from Property Wire.