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By Doug Alexander and Ilan Kolet

Canada may be on the cusp of a “severe” housing correction as real estate investment surges above a tipping point relative to economic output, according to George Athanassakos, professor of finance at the Richard Ivey School of Business.

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The chart of the day shows Canada’s housing investment as a percentage of gross domestic product, and the declines in inflation-adjusted house prices that follow when this ratio tops 7%.

“Eventually, everything boils down to demand and supply,” Mr. Athanassakos said in a telephone interview from Western University in London, Ontario. “Whenever this ratio goes over 7%, it signifies over-investment in housing and two or three years later, we have a severe correction.”

Canada’s housing market is booming as historically-low interest rates fuel purchases, driving up home prices and adding to record household debt. Canada’s ratio of housing investment to GDP has averaged 5.8% over the last 50 years and is currently at about 7%, based on Statistics Canada figures as of the third quarter of 2011, Mr. Athanassakos said. Housing investment includes spending on new homes, renovations and real estate transaction fees.

U.S. housing prices plunged by a third between the peak in July 2006 and November 2011, according to the S&P/Case-Shiller Composite-20 Home Price Index. By comparison, Canadian housing prices rose 30% in the same period, according to the Canadian Real Estate Association.

“We have experienced bubbles and busts before in Canada, it’s nothing new,” Mr. Athanassakos said. “I don’t know why this time would be different.”

Bloomberg News