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Goldman Sachs warns on 'large correction' in Canada housing

'For Sale' signs are displayed in front of new homes.
Brett Gundlock | Bloomberg | Getty Images
'For Sale' signs are displayed in front of new homes.

Canada is careering towards a sharp fall in house prices with some areas of the country's market already showing signs that overbuilding and ultralow interest rates are taking their toll on the property market, Goldman Sachs reports.

Adding its voice to a growing chorus of concern, a report from Hui Shan, an economist at Goldman, late last week warned: "what goes up can keep going up, but then tends to come down."

Ranking high-growth property markets in the last four years, Canada comes fourth behind Israel, Norway and Switzerland, according to her research. But unlike some other markets, construction activity has been trending up for years and has not shown signs of slowing down in Canada, she explained.

(Read More: Canada's red hot housing market teeters on the brink)

"If the elevated level of homebuilding persists in coming years, the risk of overbuilding will increase substantially. And if the ongoing housing boom is followed by a housing bust, the price decline can be quite significant given the excess supply of housing at that point," she said.

Housing starts in Canada have shown recent gains, trending at 190,492 units in September compared to 188,440 in August, according to Canada Mortgage and Housing Corporation (CMHC). House prices, meanwhile, continue to defy the odds, with the national average sale price rising 8.8 percent on a year-over-year basis in September, according to the Canadian Real Estate Association (CREA).

Sales activity continues to remain strong with national home sales ticking higher by 0.8 percent from August to September, CREA have said, roughly in line with a 10-year average. Inventory figures also remain stable, according to the CREA, currently standing at 5.8 months - meaning it would take that amount of time to completely liquidate current inventories at the current rate of sales activity. Both datasets indicate that demand is still prevalent to some degree.

(Read More: Fitch rings warning bell on Canadian banks)

Meanwhile, Stephen Poloz, the governor of the Bank of Canada maintains that he remains vigilant on any heat in the property market. Renewed momentum in the housing market points to a return of risk,he said in a monetary inflation report last Wednesday, despite some confidence that households were reducing their debts.

The Goldman Sachs report forecast that, in the short term, house prices may continue to increase before any "large correction", however Sebastien Galy, senior currency strategist at SocGen told CNBC that some data suggests that small pockets of the market could already be seeing that downward pressure.

In particular its figures from Montreal Island in Quebec, which is supposed be the "most solid" higher income market, according to Galy. The median price of single-family homes has dropped 7 percent (year-on-year), according to the Greater Montreal Real Estate Board. Condominiums have seen a 5 percent fall.

(Read More: Where's the next property bubble building?)

The market has also been complicated by easy monetary policies around the globe, Shan said. Central banks in the U.S., Japan and the U.K. have all embarked on quantitative easing (QE) programs which have pushed interest rates to record lows.

Shan believes the country has inadvertently imported this policy. "Lower interest rates reduce the funding costs for purchasing homes and shift the buy versus rent decision in favor of buying," she said.

By CNBC.com's Matt Clinch. Follow him on Twitter @mattclinch81

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  • Diana Olick serves as CNBC's real estate correspondent as well as the editor of the Realty Check section on CNBC.com.