This is the major finding of a study of the International Monetary Fund (IMF)titled Is the Canadian Housing Market Overvalued? A Post-Crisis Assessment prepared by Evridiki Tsounta.

Despite the limitations of econometric estimates of house-price dynamics, the measured small degree of overvaluation suggests that the Canadian housing market is essentially at equilibrium, says the report.

In its conclusion the study says:

In the last few years, home prices have first risen significantly in Canada, especially in the western provinces, and then declined markedly. This paper uses an error-correction model to assess the current extent of overvaluation in provincial house prices as measured by the CREA index. The results—which given the approximations implicit in the model and the difficulties of taking into account all possible factors in analyzing house price dynamics have to be taken with due caution—suggest that part of the increase in real house prices in the west during the late 2000s can be seen as a return to equilibrium following some “underreaction” of house prices during the 1990s (after a housing market collapse). However, more recently, marked increases in house prices led real house prices to overshoot equilibrium levels in all three western provinces considered here, with the overvaluation peaking by 2007. At the peak of house prices, we find that house prices were around 25 percent above equilibrium in Alberta, and around 17 percent in Saskatchewan and British Columbia.

In late 2007/early 2008, declining house prices have caused a large contraction in the extent of price overvaluation, now at around 8 percent for British Columbia and Alberta, and 5 percent for Saskatchewan. For the eastern provinces, we find that Ontario has experienced some price overvaluation in 2007, but prices now appear to be in line with equilibrium. Quebec appeared to have weathered the housing boom without any overvaluation. Our work generally confirms previous work (e.g., Tsounta (2009), and IMF (2004, 2008, 2009)), which find that while house prices might be a bit overvalued in the west, overall they are close to equilibrium.

The authorities have addressed possible housing market concerns in recent years, which could be important to explain Canada's housing market performance. They have purchased mortgage-backed securities, expanded the Canada Mortgage Bond program to 10-year (from five-year) maturity, enhanced liquidity, lowered mortgage rates, and announced a temporary home-renovation tax credit. In order to protect the Canadian housing market from bubbles, the authorities have also lowered the maximum amortization period for new government-backed mortgages to 35 years, required a minimum down-payment of five per cent for new government-backed mortgages, established a consistent minimum credit score requirement, and introduced new loan documentation standards. These rules, set by CMHC, limited the risk of relaxation of lending standards, and as such limited Canada's exposure to the subprime market.

Given that the overvaluation in western provinces is subdued, we don't expect to have large negative implications for the rest of Canada. With Alberta and British Columbia accounting for almost a third of Canada's GDP and a fourth of Canada's employment, an abrupt correction in their housing market could have had adverse spillovers to the rest of Canada. However, this is not expected to happen given that (i) the degree of misalignment is small, (ii) the housing market is already showing some encouraging signs of revival and (iii) commodity prices, which are closely linked with earning performance in the west, have risen considerably from their lows in late 2008.#