According to a new report conducted by the International Monetary Fund, Canada has some of the most overvalued home prices in the world. The house price to rent ratio in Canada is 85% above the average. On the opposite extreme of that scale, home prices in Japan were considered to be nearly 40% below the average.
The general makeup of the report is somewhat surprising. Most people would naturally tend to associate inflated home prices with the United States given how adversely the U.S.’s housing market crash affected the global economy. However, the United States is currently considered to have home prices extremely close to the report’s standard deviation.
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Potential Impact of Inflated Home Prices
Though home prices are not thought to represent an immediate threat to the economy, there is concern that the housing market could become unstable if the United States economy were to slow down. Another looming factor that the IMF is worried about is consumer debt in Canada, which happens to be quite high.
The IMF also stated that the main source of Canada’s economic growth over the last few years has been powered by consumer spending and corporate investments. If the housing market were to pop, that could weigh on consumer confidence and put in jeopardy the broader economy.
The IMF raised the concern that the polices of the CMHC “exposes the fiscal budget to financial system risks and might distort the allocation of resources in favor of mortgages and away from more productive uses of capital.”
Another reason that Canada’s rising prices are important is because they obviously affect home affordability. It has become much more difficult for the average Canadian to be able to afford a home loan with the way home prices have been increasing.
To give some perspective the average price for a home in Canada is at $391,000 in October of 2013. This is up 8.5% from where prices were last year. As in the United States, this has pushed more and more people to renting apartments or homes as an alternative to buying.
Possible Remedies
The IMF was quick to recommend that Canada scale back the number of mortgages that it insures through the Canada Mortgage and Housing Corporation (CMHC). By insuring fewer mortgages, the IMF argues that Canada will expose itself to less risk in the event that the economy slows down.
Roberto Cardarelli, IMF mission chief to Canada, said, “We think it has worked in terms of guaranteeing the stability of the financial system and discouraging bankruptcies and can be used as a policy too. You can use it to boost the market if you need to, you can use it to cool the market.”
Keeping interest rates low until at least the end of 2014 was another policy that the IMF endorsed. This is already the current policy at work in Canada and is designed to encourage more people to take out mortgages in order to drive housing sales and distribute risk.
