Putting real estate overvaluation in perspective

More than a few media headlines are focusing on Canada's overvalued real estate. According to Fitch, an American-based ratings agency, housing prices in Canada are 20% overvalued in real terms. The fine print, however, is that this overvaluation only applies to a couple of major urban centres, such as Toronto, Vancouver and Montreal.

In their new financial model report, Fitch analysts noted that housing prices in Canada have continued to climb since 1996 and, while small corrections have occurred, these prices have risen without the support of underlying financial fundamentals.

For that reason, the ratings agency suggests that the overvaluation of real estate in certain provinces is in the double digits. For instance:

* Ontario is overvalued by 21%
* Alberta by 15%
* British Columbia by 26%, and
* Quebec by 26%

Still, Fitch analysts don't believe the overpriced real estate markets will result in price declines that equal or exceed the overvaluation rates.

"Actual nominal [price] declines could range from the low single digits for Alberta, up to more than 15% for B.C. and Quebec."

The key: these declines will occur over the next several years. More importantly, the price decrease will be closer to 10% of home prices not 20%, explain Fitch analysts.

Of course, certain markets have already felt the pinch. In Alberta, low crude oil prices in 2008 forced a price correction. In B.C., there was a 29% drop in year-over-year sales in February-signalling a cooling in what is considered Canada's most overvalued market.

For buyers willing to sit out another five or so years this could mean a drop in home prices. For example, a home listed for $450,000, today, could drop in cost to $405,000 within the next five years.

Good news for the patient homebuyer, but the decision to wait and buy should also factor in potential rising interest rates as well as job security and economic growth. If discounted five-year posted interest rates go up to 5% in the next five years-an increase that’s not out of the realm of possibility-then you would pay $2,249 per month (based on a 5% five-year fixed rate for a 25 year amortization on a $405,000 home, with 5% down). If you bought now, you’d be paying $2,025 per month (based on a 3% five-year fixed rate mortgage for a 25 year amortization on a $450,000 home, with 5% down).

http://money.ca.msn.com/banking/homebuyersguide/putting-real-estate-overvaluation-in-perspective