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Is Canada about to face US-style housing meltdown?

Skyrocketing home prices in Canada, particularly in cities like Toronto, are fueling concerns that Canadians are overspending as they assume – as the US did – that real estate prices can only go up.

By Anita ElashCorrespondent / May 29, 2012

The CN Tower is reflected on an end table in the dining room of the Ritz Carlton residents model suite in Toronto May 1.

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Toronto, Canada

Actor and broadcaster Jeff Douglas says he knows there are “more responsible” things to do than take on a mortgage he will likely have to pay until he turns 70.

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But that didn’t stop him and his wife, interior painting contractor Ana Maria Diez, from charging headlong into the battleground that has become the Canadian real estate market.

Mr. Douglas and Ms. Diez fell in love with and purchased a 1,300-square-foot duplex in a middle-class west Toronto neighborhood last month for $632,000. Like an increasing number of Canadian buyers, they sealed the deal after duking it out with several other couples who also wanted the house. They placed no conditions on their contract and finally paid 112 percent of the original list price of $555,000.

“It was one of the last houses I think we’d have a shot at because the price of houses in Toronto goes up every week so it was definitely a now or never situation,” says Douglas. “At $625,000 ($632,000 in US dollars) we feel like we got a bargain.”

Douglas and Diez may feel lucky. But house purchases like theirs are increasingly fueling concerns that, like their American neighbors a few years ago, Canadians are spending themselves into financial disaster.

“What we are seeing is the irrational exuberance that was present in the US,” says David Madani, a former Bank of Canada analyst now with the consultancy Capital Economics. “It has all the symptoms of a disaster waiting to happen.”

Fueled by record low interest rates – earlier this winter, major Canadian banks offered five-year, fixed-term mortgage loans for just under 3 percent (the average for a five-year term is 3.49 percent) – and an economy that was largely unaffected by the 2008 economic crisis, real estate prices in Canada have taken a steep turn upward.

Nationwide, they have nearly doubled in the last 10 years, to an average of about $373,000. In some large cities, such as Toronto and Vancouver, they are up more than 10 percent year over year. Stories of bidding wars, like the one this winter in which a young woman paid $1.18 million, or more than $400,000 over the asking price, for a suburban Toronto bungalow, have become common.

Although buyers seems convinced that real estate prices can only go up, Mr. Madani, along with the International Monetary Fund, the Economist magazine, and various independent and bank economists, warns they are already overvalued by as much as 25 percent. Madani warns they are likely to drop by at least that much over the next few years. If that happens, he says, the drop in consumer spending and investment in housing would likely be dramatic enough to push the economy into recession.

“If credit tightens tomorrow, the game is over,” adds Ben Rabidoux, an analyst with the US real estate market research firm M Hanson Advisors and the author of the website The Economist Analyst.  “I think we will see a decade of stagnant returns and a stagnant economy.”

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