Canadian Housing: Pricey, Not Dicey

November 19th, 2010

Here is a recent report by BMO regarding housing prices nationally.

The media and some analysts remain glued to the idea that the Canadian housing market is a bubble ready to implode à la the U.S., Ireland, Britain, and Spain, where prices have dropped 22% on average. The latest concerns were fanned by an article in The Economist that suggests the Canadian market is 24% overvalued based on a comparison of prices and rent. Rent captures the stream of income derived from housing, and thus, in theory, is an appropriate valuation metric. However, in practice, it is important to note that statistical agencies often have difficulty measuring effective rents. Moreover, the downward trend in interest rates in the past three decades would normally favour ownership over renting and, hence, encourage a higher price-to-rent ratio today than in the past (Chart 1). Perhaps for these reasons, of the 20 countries reviewed by The Economist, the median overvaluation was 20%, and only four countries were overvalued by less than 10%, casting some doubt on the appropriateness of this metric.

In our view, comparing house prices with personal income, rather than rent, provides a superior methodology. As shown in Chart 2, the historical trend for this ratio has a zero slope, meaning prices tend to rise alongside incomes over time. This makes sense, since a family’s income largely determines how much it can pay for a house. continue…

Thank you ! We have received your message.