Ok, so far I’ve been wrong on my view of the Canadian residential real estate market. My first article, the Canadian Real Estate Bubble? was back in March 2011. I also wrote back in October 2011 that the CMHC was a key player in inflating the bubble and likely to come under stress when prices fell. However, its March 2012 and prices (and debt) continue to rise.
I want to address the most common argument against a bubble.
“Mortgage service costs are affordable therefore housing prices can’t be a bubble.”
This is a fair argument but it assumes record low interest rates going forward. Also, debt per family is at an all time high, any increase in rates (or a recession) will send shock-waves through the real estate market. Eventually, house prices will return to a function of the region’s income per family.
To judge current prices, Analysts often use historical housing over the last 25 years. Although that seems like a fair amount of historical data it places the base year in the late 1980s which was the last time Canada had a real estate bubble. Obviously prices don’t seem very expensive when you compare them to a prior bubble.
It becomes more difficult to find data as you go further back than 1980 but there was an article from the Toronto Star in 2008 that looked at Toronto’s historical house price to income ratio. It’s shocking to know how low real estate prices can go relative to incomes. Looking at 1979, housing prices were only at 1.11x price to household income. Of course interest rates were far higher at the time and a mortgage would have been difficult to pay but that’s my point, interests rates and house prices eventually return to a normal level. Be greedy when others are fearful and fearful when others are greedy.
To update the data to 2012, Toronto’s average price to family income ratio is 6.7x (Canada’s is 4.9x, source: BMO special report January 2012.) Can it go higher? Sure, Vancouver’s ratio is 10x! But that’s not the point. When making what is likely to be the single biggest investment decision in your life you should buy based on a reasonable long term value not what you can afford given ultra low mortgage rates.
I still think Francis Chou’s advice is best for potential home owners:
“Based on ratios such as rent-to-house-price and disposable-income-to-house-price, Canadian house prices are out of line with historical standards. In addition, household debt as a percentage of disposable income is unprecedentedly high. This does not mean that Canadian real estate prices will decline soon, but it does indicate that valuations are stretched. We would be cautious in this environment. If there is a choice, it is better to rent rather than buy a house. However, if you are determined to buy a house, we would urge you to do so without borrowing too much money.”
See also: George Athanassakos’s article: Canada’s housing bubble: This time is not different.
Get Our Free In-Depth Books On Famous Investors and like our Facebook page for latest news updates and leaks. Also sign-up for our free under the radar small cap newsletter.