Tuesday, November 12, 2013

The Mirage of the Never-ending Canadian Housing Market Bubble

It seems that no matter what, Canada's housing prices keep rising.  Obviously, what goes up can come down very quickly.  To that end, a brief analysis from the OECD examines house prices across the OECD nations, including Canada, and compares two ratios; the price-to-rent ratio and the price-to-income ratio.  Let's start by explaining the two ratios:

1.) Price-to-income: this ratio measures the affordability of housing as it relates to household income.  Obviously, when this ratio is high, a housing market is less affordable.

2.) Price-to-rent: this ratio measures the profitability of owning a home.  This ratio compares the total cost of owning a home to the cost of renting a similar property.  The total cost of ownership includes mortgage principal and interest payments, insurance, property taxes, mortgage insurance and any closing costs.  Once again, when this ratio is high, it is less expensive to rent a home than it is to buy a home.

Where both the price-to-income and price-to-rent ratios are high, a residential real estate market is considered to be overvalued.

Here is a bar graph from the OECD analysis showing the aforementioned ratios for the world's developed economies:

Here are the top five nations with overvalued residential real estate measured using the price-to-rent ratio (in blue):

1.) Norway - ratio of 71 

2.) Canada - ratio of 64

3.) Belgium - ratio of 63

4.) New Zealand - ratio of 61

5.) Australia - ratio of 37

Here are the top five nations with overvalued residential real estate measured using the price-to-income ratio (in red):

1.) Belgium - ratio of 49

2.) France - ratio of 33

3.) Canada - ratio of 30

4.) Norway - ratio of 27

5.) New Zealand, Sweden and Netherlands - ratio of 23

Notice that Canada has the second highest overvalued residential real estate market when measured in terms of price-to-rent and the third highest overvalued market when measured in terms of price-to-income.  Canada's average ratio of 47 puts it in third place after Belgium at 56 and Norway at 49.

In sharp contrast, Japan which at one time had some of the world's most overpriced real estate now finds itself with the developed world's most affordable residential real estate with a price-to-rent ratio of -38 and a price-to-income ratio of -36 for an average of -37.  In the case of Japan, here's what happened to the price of commercial (line with circles), residential (line with squares) and industrial (line with triangles) real estate in six major city areas from 1985 to the present:

Residential real estate fell from a value of 218.8 in 1990 to its current level of 76.3 (end of March 2000 = 100) after rising by 33.1 percent between 1985 and 1990. 

It's becoming increasingly obvious that, despite more-or-less continuous rises in Canadian residential real estate valuations, the bubble will not continue to inflate forever, particularly given this:

With average Canadian hourly wages rising by only 5.6 percent over the past three years and Canada's 11 City House Price Index rising by 13.8 percent over the same timeframe, it is obviously becoming increasingly difficult for a Canadian family to afford to purchase a home, a situation that will inevitably put downward pressure on housing prices.  The current housing bubble in Canada is a mirage that only appears to have no end.  


  1. The word has been out since summer. Its still a good thing that you mention this bubble again because there are a lot of people in denial and lots more that are delusional (prices will never go down). Garth Turner talks about this incessantly and at great length on his blog " http://www.greaterfool.ca/". Still, people drink the kool-aid served by the banks, CREA, RE agents, and family. "Buy now or be priced out forever"

    John in Mtl

  2. Toronto and BC Lower Mainland prices skew the Canadian average. Take out those two data points and I believe the numbers look more reasonable.
    I don't know about Toronto, but Lower Mainland residential prices are driven by offshore demand. I suspect the price-to-income ratio does not account for the fact that foreign buyers' income is based overseas. Measuring income from Canadian employment is not very relevant in the case of Lower Mainland. Likewise foreign buyers would not see renting as an alternative. They want to own, so price-to-rent is not particularly relevant. Mortgage restrictions have little effect either, since the foreign buyers like to pay big down payments or all cash. By world standards, I believe Vancouver residential prices are comparable to other large cities targeted by the global wealthy. The offshore buyers like the range of Asian-language services available in the Lower Mainland, and also the Canadian education and health care systems.
    This situation is not okay. Working Canadians cannot afford to live in the Lower Mainland. The current governmental policy levers do not have any effect, so Lower Mainland prices are going higher until such time as a big recession hits Asia. Something has to be done about it. We need European style land ownership laws the way they have in Germany and Switzerlend for Lower Mainland BC.

  3. Thanks for your comments. I do agree that Toronto and Vancouver are skewing the overall data, however, if I look at real estate in other parts of Canada including some parts of the Maritimes and Southern Ontario well outside of the GTA, valuations are still ridiculously high compared to what people can really afford given the wages paid in those areas.

  4. Toronto and Vancouver are not skewing the overall data. if you look at major cities accros the country, the pattern is uniform. see home prices charts for major canadian cities since 1975 here. http://www.torontocondobubble.com/2013/11/housing-bubbles-in-canada-by-city.html

  5. Population in Toronto Vancouver is continuously increasing leading to higher rental prices, this will go long as this year more expats are expected to move in city.

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