• The Bank of Canada has developed a new model to determine the overvaluation of housing prices in Canada and has, for the first time, provided its own estimation.

    “There is considerable uncertainty associated with identifying and estimating a benchmark model of house prices. Therefore, any single measure of valuation should be interpreted with caution,” the Bank of Canada wrote in its FINANCIAL System Review – a comprehensive, 53 page report released Wednesday. “In practice, two main approaches have been used, the first based on very simple indicators and the second on more elaborate econometric models of the housing market … Bank staff have developed a new model of house price determination that adds to the available estimates.”

    According to the central bank, the two traditional methodologies created wide estimate ranges, due to the very different methods used to calculate valuations.

    For example, TD Bank and the International Monetary FUND (IMF) both believe Canada’s house prices are overvalued by ten per cent; Fitch Ratings suggest they are overvalued by 20 per cent and The Economist believes the figure sits around 30 per cent.

    The Bank’s model attempts to address this issue. According to the report:

    The model is designed to address some of the problems noted above by incorporating data on house prices in 18 oECd countries from 1975 to the present.  There are 43 major house price cycles in this sample, which allows the estimation method to obtain more precise estimates of the model’s parameters. However, like other models, it suffers from a number of shortcomings . For instance, house price fluctuations in each country are determined solely by changes in demand conditions (i.e ., real, per capita disposable INCOME and a long-term government bond yield) . The supply side is not explicitly modelled . Constant cross-country differences are captured by country-specific intercept terms, but differences that vary over time are not included.

    The new model estimates house prices are overvalued by 10-30 per cent; a range that is line with several other organizations’ figures.

    The BoC also produced a graph that charts housing affordability figures dating back to 1975. According to the graph, house prices in Canada have been overvalued, to some degree, since 2005.

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