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Canada's housing market overvalued, but crash worries ease

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Canada's housing market is overvalued but prices are expected to continue to edge higher in the years ahead, according to a Reuters poll that showed less concern about a U.S.-style crash than three months ago.

The survey of 19 forecasters showed previous concern about a sharp drop in prices has dissipated over the past three months. Most analysts now predict a gradual rise in national prices and resiliency even in Toronto and Vancouver, the two markets considered most at risk of a bubble.

Canada's housing market has cooled from the most feverish activity so far, in the middle of 2012. Economists, many of whom once expected a sharp price correction, now have a long list of reasons why the market will keep climbing.

They argue that solid rates of immigration, persistently low interest rates, and even limits on homebuilding to preserve green space in some major cities, will underpin the market.

"The main reason people are dismissing a hard landing view now is that we've seen corrections in the last five years, but they have been short-lived," said Sal Guatieri, senior economist at BMO Capital Markets.

The Canadian housing market weakened in 2009 in response to the global financial crisis and recession, but then stormed back before the government tightened mortgage lending rules several times, most recently in mid-2012.

That last move, the fourth effort by the government to rein in lending since the crisis, caused a sharp pullback in demand late in 2012. But home buyers once again came back with strength through the spring and summer of 2013.

While official interest rates are expected to remain at a near-historic low of 1 percent through 2015, gradually rising mortgage rates should help prevent a re-igniting of the housing boom, Guatieri noted.

In the U.S., where house prices crashed by more than a third and are rising again, concerns over a new property bubble are now fading, according to another Reuters poll.

CONSTRUCTION FALLING

On a national basis, Canadian house prices are expected to rise 3.1 percent in 2013, 1.5 percent in 2014 and 2.0 percent in 2015, according to the median results of the poll, which was conducted over the past week.

Price declines have even been ruled out in Toronto, Canada's largest housing market, and Vancouver, the country's most expensive, according to the median of forecasts.

Toronto prices were forecast to rise 4.0 percent in 2013, 1.5 percent in 2014 and 0.5 percent in 2015. Vancouver prices were expected to edge up 0.3 percent in 2013, 1.0 percent in 2014, and 0.8 percent in 2015.

Craig Wright, chief economist at Royal Bank of Canada, the nation's largest lender, said it is remarkable how the bounce back in 2013 has changed the minds of so many doomsayers who predicted Canada would suffer a U.S.-style housing crash.

Wright is one of just two respondents predicting a decline in national prices, albeit by just 1.0 percent, in 2015.

"We've been consistently in the 'cooling not collapsing' camp and we're still there," he said. "We are looking at a situation where the sales-to-listing ratio has moved off its highs and is starting to drift lower, and that's usually an environment where prices soften somewhat."

House prices, which rose some 88 percent in the last 10 years, according to the Teranet-National Bank Housing Index, are still rising on a national basis, but the appreciation has slowed to a crawl and some markets are falling.

Asked to rate Canada, Toronto and Vancouver house prices on a scale of 1 to 10, where 1 is extremely cheap, 5 is fairly valued and 10 is extremely expensive, analysts rated Canada at 6.3, Toronto at 7 and Vancouver at 8.5.

Housing starts, which notched a seasonally adjusted annual rate of 214,827 in 2012, are expected to slow from an annual rate of 190,000 units in the fourth quarter of 2013 to 177,700 units in the third quarter of 2014, the poll showed. That's considered roughly in-line with annual household formation.

TOO MUCH DEBT?

Canadian policymakers, including the Conservative federal government and the Bank of Canada, have expressed concern that Canadians are taking on too much debt - in particular cheap mortgages - at a time when interest rates and bond yields are near record lows.

The ratio of household debt to income rose to a record high of 163.4 percent in the second quarter from 162.1 percent in the first quarter.

Growth in household debt as a percentage of gross domestic product since 2006 was faster in Canada than anywhere else in the world, according to World Bank data.

Indeed, because Canada never had a sharp housing market correction like in the U.S., households balance sheets have kept expanding throughout the post-crisis years.

But only 4 of 17 respondents expect the government to take additional measures to cool the market.

And only 5 of 14 respondents expect the Office of the Superintendent of Financial Institutions (OSFI), which oversees the Canadian banks, to do more following its past efforts to make sure lenders aren't fueling a bubble.

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