Examining house prices and rents across the provinces
MAY 14, 2011
Prices and rents revisited:
Earlier in the week, we examined the changes in house prices and rents in the largest cities in Canada. We also spent quite a bit of time discussing why changes in rents are one of the measures of fundamental value when it comes to residential real estate. If you are unclear on this, I suggest you re-read the post again. It is important in appreciating the data I am going to present in this post.
Quick note: I've added to graph for Montreal now that I've accessed the historic house price data for that city.
The bottom line is that when there is a massive divergence in the growth of rents and the growth in house prices, there is always at some point a realignment. While in theory the realignment can occur through a rapid rise in rents, this is seldom the case. For starters, strict rent control in a handful of provinces prohibits this. But beyond this, it is simply not the experience of numerous other housing markets that have experienced such anomalies.
As a prescient paper written by the Federal Reserve Bank of San Francisco noted, "We found that most of the variance in the price-rent ratio is due to changes in future returns and not to changes in rents. This is relevant because it suggests the likely future path of the ratio. If the ratio is to return to its average level, it will probably do so through slower house price appreciation."
With that said, allow me to present the provincial data. For reference, the rental data is from the Consumer Price Index rental component (CANSIM table 326-0020) while the house price data is from CREA.
Discussion:
Note that in every province except BC and Ontario, house prices and rents have closely paced each other before abruptly diverging in the early to mid 2000s. So what is the deal with Ontario and BC? There may well be a historic and stable premium relative to rent that buyers have been willing to pay to live in those provinces. Furthermore, rental controls may have had some impact in keeping rents subdued in both provinces, though that hardly explains why other provinces with strict rent control (such as Manitoba) have seen house prices and rents track so closely.
Let's assume that the price premium in these two provinces is permanent. Just how much of a premium buyers will be willing to pay is now the huge question. Given the parabolic move in house prices relative to rents in both provinces, it's clear that house price premiums relative to rents have increased as quickly as in other provinces. So while they two lines may never touch again, it's an exceptional stretch to believe that they won't at least narrow.
All fundamentals that we have examined thus far suggest that a level of overvaluation exists. The drivers of house price appreciation are complex and involve both psychological, economic, and monetary influences. Any one metric cannot provide a complete snapshot of the state of housing in Canada. Yet when numerous metrics all point to a significant overvaluation issue, people would be advised to think long and hard about the implications for house prices appreciation going forward. Even more importantly, it's time we begin to consider the economic repercussions of a more rapid realignment of house prices with underlying fundamentals. For more on that, check out these two posts (part 1 and part 2)
Those fundamentals have been discussed in the following posts:
House prices and economic growth (part 1 and part 2)
House prices and income growth (part 1 and part 2)
House prices and population growth and inflation.
And for more on the price/rent ratio and using it to determine whether it makes sense to rent or to buy, check out this post.
Oh, and by the way, here is the US experience with house prices and rents:
We know how that ended. Is it really different this time? Can our parabolic move in house prices relative to rents continue indefinitely?
Cheers,
Ben
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12 Comments
I have said this before. The main reason for paying a premium in Vancouver is that quality rentals are non existent, especially if you are looking for a 3 bedroom rental.
That is why people with family and 2 kids are so hard pressed to buy, no matter the market fundamentals. You need a stable place to live if you have kids.
This is not really possible in Vancouver right now if you are looking to rent a 3 bedroom place. Or you will be paying very close to mortgage payment on such a quality rental. Go and check for yourself, most affordable 3 bedroom places either are basement suites or complete junks. A decent place will cost you in rent very close to mortgage payment if you buy it with a 5 year fixed. i have done this exercise myself.
Of course interest rates could go up and many things could happen after 5 years, but in the meantime you need a nice place to live.
you are 100% correct, many people just don't get it.
I have 2 kids, 4 and 2 years old, we just switch( 12 months a go) from a big house to a medium size appartement, the one with the biggest problem with this change its the wife. But with the numbers coming in lately she just switch her opinion, she preferred a nice place, but the money involve in a correction off this magnitude, and the number of possible amazing deal is now to atractive, I was in the market in 1998, you just can believed the difference from now. I know THIS TIME WILL COME BACK. So waiting for me, is really easy. People who buy now for not having some discomfort, will have allot more negative emotion down the road. I Hope i am rong.
It is hard to argue that there isn't a dearth of family-oriented dwellings for rent in Vancouver. A dropping school-age population and the constant threat of school closures is testament to this. Unfortunately, paradox, the city has its head in the sand and is too addicted to speculative condo revenue.
Write your MLA and council members. Both have elections coming up this year or next so will be in populist overdrive mode.
...Write your MLA and council members...
I prefer to waste my time writing here, where from time to time I get to read some illuminating comment rather than writing my mla, which is a complete useless effort.
The political process is complete waste.
I think long term the democratic process has to be democratised as we are now heading in all major democracies to a two party system taking turns while giving the illusion of choice to the masses, whereas in reality there is only one elite managing expectation and taking care of each other.
I dont see any change in my lifetime to this process, as young generations have become mainly gadget addicts without interest in politics or society as a whole.
paradox, I do feel the same way but that should not stop you from trying, and organizing with others who have similar interests. My feeling is that higher prices will have more broad-based concern than just renters. Business owners have trouble attracting top talent to areas with high real estate prices. Parents lament at their children unable to afford property in the neighbourhoods in which they were raised. School boards are facing closures because of unaffordable demographics for families. There is reason to think that an ongoing and strategic effort to elicit those who see the various problems with high prices will have some effect, especially in an election year.
It is not acceptable to throw up one's hands. Organization and directed messaging can have some effect and it has worked in the past. I agree one person is unlikely to make a difference.
Rabi,
Love the blog. Very impressive all around. Do you think the national ratio has been driven by Alberta, Sask & NFLD in 2007-2009, with the advent of oil averaging $75-90 a barrel? All of those provinces are heavy suppliers, and it would seem that the graphs you provide run parallel to the spikes in oil. Do you think a lot of Fort McMurray, Regina & St. Johns extra disposable income could be driving the prices nationally?
Cheers,
Neilly D.
Hey Neil
Welcome to my humble blog. Your question is a good one. While in theory higher oil prices should benefit certain provinces, it is highly debatable whether they are a net positive or negative influence on economic growth in general as higher oil prices eat into disposable income, and hence consumer spending, which makes up the lion's share of economic growth. That's just considering domestic demand. Just as importantly, they serve as a major headwind to the US economy, by far our largest trading partner. Every 1% increase in oil prices equates to a $1 billion drag on consumer spending in the US.
In theory high oil prices should buoy incomes in certain provinces, and indeed they have. But once again, have house prices outpaced even that increase in income?
I wrote a couple post examining this exact question:
http://www.theeconomicanalyst.com/content/examining-house-prices-and-inc...
http://www.theeconomicanalyst.com/content/examining-house-prices-and-inc...
At the end of the day, incomes have increased in the provinces you describe, but house prices have still far outpaced them.
Hope that helps answer the question.
My Canadian commodity concern is summed up in this chart.
http://i55.tinypic.com/2iu9x5j.png
I think the NL and Alberta phenom are nested. Much money made in Fort McNewf repatriates to NL. There's also the Newfoundwealth/credit mentality, i.e. it's our turn to live large after having been beat down for so long. Newfoundpride indeed.
Paradox makes a good point.
As a renter of a 3 bedroom suite on Vancouver's West Side, we are soon to be pressed into buying into the real estate market. The house we live in is now on the market and we are sure to get the renoviction in the near future. We currently pay $1600/month and have more than enough in equity to put $250K-$300K down on a $550K place.
If our rent goes up by any more it will push us over the line on the rent vs. buy debate. If we start paying $1800-$2000 month for rent then I will amortize a mortgage. Presently $1600/month will amortize a $337K mortgage over 30 years at 3.99%. $1800/ month will amortize a $379K mortgage and $2000/month will amortize a $420K mortgage.
My wife and I do not want to be slaves to our mortgage and property though, so we will try to keep the down payment high and the payments low.
I work as a mortgage broker and have done all the math on the situation and yes the Vancouver real estate market is way over priced and after 32 years of living here it really does rain to much. As much as I would like to live in the Okanagon we still have to work and live in Vancouver.
Given the likely future fall in canadian home prices, aside from selling ones own home is there an investible way to profit from this outcome