OCTOBER 03, 2011
Please read part 1 of this two part series for a detailed explanation of why house prices and rents tend to move in tandem over long periods of time. In that post, we examined house prices and rents in some larger centres from BC east to Manitoba. Today, Ontario and the rest. If your town is not included, it's not for lack of trying on my part. The available data only covers so many towns.
Once again, these graphs show the rise in both house prices and rents with both variables set to 100 in 1992. This does not show nominal data, but rather the change in each variable, which should, as we know, be roughly equal.
Let's let the graphs speak for themselves...
Once again we see that there is no 'Canadian' housing bubble. While I would say that there is a bubble in the average resale house price in Canada, it's quite clear that it is not uniformly distributed, nor will the fallout affect all communities equally. Several Western provinces and some larger Ontario cities have made an outsized contribution to the rise in the average resale house price. With increasing signs that a top in the market is forming or already past us, it seems that these same cities will provide the bulk of the downward pressure on average house price data going forward.
Interestingly, we see that house prices in most cities tracked their respective rental index until the early 2000s. I'd suggest that there are several reasons for this:
1) When the tech stock bubble imploded in the US in 2000, many investors were burned badly as they watched their savings disappear seemingly overnight. At the same time, to fend off a looming recession, the Fed in the US, and the Bank of Canada, cut interest rates. You can see this in the following graph. Notice that the overnight rate from the Bank of Canada fell from 6% down to 3% after 2001.
The stability of the housing market during this stock market turbulence, coupled with falling interest rates, ushered in a new mentality towards housing as an asset class. This shifting mass psychology can be seen in the charts from this post.
2) Just prior to this, down payment requirements in Canada were cut from 10% to 5%. This kicked off a decade-long experiment with loosening credit requirements for real estate:
- A brief foray into zero down mortgages (still technically continuing if you consider the cash-back offerings at all major banks)
- An extension of amortization rates up to 40 years, then back to 35, and now 30
- The removal, in 2003, of CMHC's regional cap on amount of mortgage they would insure
The result has been a massive expansion in mortgage credit outstanding, from 40% of GDP in 2000 to almost 65% of GDP in 2011. This does not include home equity lines of credit, which are calculated as consumer debt and have been the fastest-growing form of debt in Canada.
As I explained in part 1 of this series, rents are paid out of income, while house prices are financed with credit. Because of this, the expansion in credit that we've seen has boosted house prices but has left rents lagging well behind. Ultimately, this is not sustainable as even house prices are constrained by the incomes needed to support mortgage debt. Interestingly, we've also seen how house prices relative to incomes look in Canadian cities in this 3-part series. It's ugly.
Ultimately, we all will fall into one of two camps. We will either recognize that the metrics of house prices and rents will once again realign, likely by stagnating or falling house prices, or we embrace what famed investor Sir John Templeton called the four most dangerous words: This time it's different.