OTTAWA - An overbuilt and overpriced condominium market is posing a risk to Canadian households, banks and the economy in general, the Bank of Canada warned Thursday in its latest review of the health of the country's financial system.
The central bank particularly singles out the Toronto condo market, which it notes continues to carry a high level of unsold high-rise units in both pre-construction and under-construction phases.
It urges policy-makers to continue monitoring developments in the sector, saying it is "working closely" with federal authorities to maintain an ongoing assessment of risks.
Overall, the bank says it believes both global and Canada financial conditions have improved somewhat despite the subdued pace of the economic recovery.
In Canada, the growth in household credit has continued to slow and has fallen broadly in line with growth in disposable income. As well, overall activity in the housing market has moderated.
But the central bank is still worried about the housing market, and particularly condos in Toronto.
"If the upcoming supply of units is not absorbed by demand as they are completed over the next 12 to 30 months, the supply-demand discrepancy would become more apparent, increasing the risk of an abrupt correction in prices and residential construction activity," it said.
"Any correction in condominium prices could spread to other segments of the housing market as buyers and sellers adjust their expectations."
That could start what the bank calls a negative feedback loop. A plunge in house prices would bite into net household worth, shatter confidence and consumer spending, impacting income and job creation.
"These adverse effects would weaken the credit quality of bank's loan portfolios and could lead to tighter lending conditions for households and businesses. This chain of events could then feed back to the housing market, causing the drop in house prices to overshoot."
The paper is the first major publication from the bank under new governor Stephen Poloz, and it suggests the former Export Development Canada chief executive is in sync with his predecessor, Mark Carney, about the dangers of a housing market propped up by super-low interest rates.
Earlier Thursday, Statistics Canada reported the price of new homes nationally rose 0.2 per cent in April from the previous month. Economists had expected a 0.1 per cent increase.
Bank of Montreal senior economist Robert Kavcic said the central bank is correct to keep the focus on the No. 1 domestic risk facing the economy.
"There are about 50,000 units under construction right now ... and the demand is probably not going to be there to absorb that, so it's a risk," he said.
In his own analysis, Kavcic said there is not much upside to buying into the Toronto condo market over the next five years, so he recommends renting.
The central bank cautions that it is not actually predicting an unravelling of the housing market and still expects a relatively soft landing, in part because interest rates are likely to remain low for some time.
"Nevertheless, simple indicators continue to suggest some overvaluation in the housing market; house prices are high relative to income and housing affordability could become a concern when interest rates begin to normalize," it adds.
The continuing highlighting of household imbalances, despite noting that the risks have in fact lessened somewhat in the past six months, suggests that Poloz is as worried as Carney was about the long-term dangers of low interest rates, even if the system appears sound today.
Last week, the OECD singled out Canada as one of three countries in the advanced economies with the most overvalued housing market. It calculated that prices, which continue to rise, were 64 per cent overvalued compared with renting costs.
Any number of shocks could send Canada's housing market tumbling, the Bank of Canada says, particularly higher borrowing costs that pinch households already carrying record-high levels of debt.
Even an intensifying of the ongoing euro-area financial crisis, which could occur because there are signs Europeans are becoming weary of austerity, could trigger problems here.
"If the situation were to occur ... trade and financial linkages could spread the shock to other regions, leading to a more severe and protracted reduction in global demand. This in turn could trigger a sharper correction in Canada's housing market."
The bank says even if the worse does not happen it will take years for Canada's housing imbalances to right themselves.