Canadian real estate prices are plummeting, but have a long way to go before the froth dissipates. BMO warned investors over the long weekend that home prices deviated from the trend by up to 76% in Q1 2022. Home prices historically only add a small premium to real wage growth and interest rates. However, Canada is currently seeing the widest deviation in the past 40 years. The bank expects a significant correction through 2023.
Canadian Real Estate Prices Are Massively Overvalued
Canadian real estate has made an unusual deviation from the trend, making it clear this has been a bubble. Since 1980, BMO estimates home prices have increased 3% per year in real terms. The bank says this roughly reflects real (inflation-adjusted) wage growth and interest rates. That changed recently.
Over the past two years, home prices have climbed 38% above trend, noted the bank to investors. Prices have jumped over a third in the past two years, going waaay past the baseline trend. Deviations from the trend are better known as overvaluation, and tend not to stick around too long. Canada has never seen such a large gap above the trend — at least in the past 40 years.
It’s A National Bubble, But Southern Ontario Is The Worst
The bank warns most of the country has seen frothy gains, with a few exceptions. However, Ontario is pushed to an extreme, with home prices 55.4% higher above the trend, as of Q1 2022. It’s worse in Southern Ontario, with Toronto (+41%), and its exurbs (1 to 2 hours away) rising 76.3% overvalued. Cottage country (+63.6%) has also gotten ahead of itself, and won’t have fun discovering where its true value should be.
“While Toronto prices were 41% above trend, exurbs (using markets 1-2 hours outside Toronto) were ahead by more than 70%,” warns the bank.
Other regions also have steep trend deviations, including Atlantic Canada (+34.7%), Quebec (+32.6%), and BC (+21.4%). Those might not look huge in contrast to Ontario, but if normalization were to occur and a third of price gains were trimmed — you probably wouldn’t be too happy.
Not all provinces are suffering from this steep overvaluation. Manitoba (+12.3%), Saskatchewan (-3.4%) and Alberta (-5.0%), all had a relatively small climb, or dropped in the case of the last two. Consequently, there isn’t nearly as much to correct.
A Canadian Price Correction Is Already Underway
It’s hard to find someone that hasn’t noticed this recently, but Canadian real estate prices are doing the unthinkable — falling. Home prices are down 8% from the February peak, with many local markets down even further.
BMO explained to investors, “a price correction in Canadian housing is well underway, and many local markets are easily already down 20%. We expect the adjustment to run through most of 2023, as the market absorbs the sharp increase in borrowing costs, while a broader economic slowdown also weighs on previously raging demand.”