DECEMBER 23, 2011
At some point I would like to address some of the issues with the report, particularly some of the findings that completely disagree with some Stats Can and Bank of Canada data (most notably residential mortgage credit outstanding, which is under-reported by 25% and home owner equity positions which significantly differ from our stats agency calculations). But that will have to be for another post....if I can find the time. The report is full of tidbits regardless.
I did find this chart particularly interesting:
It shows the price/rent ratio of the largest cities in Canada. Note that Van is roughly 60, TO and Montreal are roughly 35, while Calgary is in the low 30s. Below is a chart from the NY Times showing price/rent ratios in US at their peak.
I can’t verify that the methodology is identical, but I think the general picture is clear: The ownership premium in the largest Canadian cities is unprecedented, dangerous to new buyers, and unlikely to persist. And if analogies to the US situation are at all valid, this is bad news.
To further frame it, if the methodology is at all comparable, it implies that valuations in Vancouver are off the charts compared to any US city at peak, Toronto and Montreal valuations are as stretched as Palm Beach and San Diego were at peak, while Calgary valuations are comparable to Las Vegas.
While this sort of ‘analysis’ is admittedly shallow and does not look at other macroeconomic variables, it’s nevertheless troubling considering the findings of a prescient research note from the Fed Reserve Bank of San Francisco which sounded an early warning bell in the US by looking at this very metric:
The majority of the movement of the price-rent ratio comes from future returns, not rental growth rates. This will not comfort everyone, as it implies that price-rent ratios change because prices are expected to change in the future, and seemingly out of proportion to changes in rental values.
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.
I personally am a huge believer that rents underpin residential house values, a topic I have explored at great length on this site:
Because of this, I am greatly troubled by the unprecedented gap between house prices and rents, which the IMF recently calculated is the most stretched in the developed world:
Edit: As one commenter noted, this metric is not without its limitations. From TD economics:
"There is no definitive measure that one can point to quantify the degree of excess (with absolute certainty) imbedded in average residential prices in Canada today. Each measure carries with it some underlying concern about the conclusions that can be made. For example, if we use the average price-to rent ratio as a benchmark, the ratio inherently ignores the impact of changing mortgage rates, the presence of provincial rent control measures, and a potential divergence in quality between owned and rental accommodation."
These are all concerns that were raised in the US c.2005, most vocally by those whose incomes were tied to the ongoing strength of the market. Virtually every metric that academics use to gauge house price vulnerability points to cause for concern. But as the old saying goes, it's difficult for someone to see the error in their thinking when their income is reliant on them NOT seeing it. Only those whose livelihood is tied to the housing market could possibly brush these metrics off without consideration of their message.
At any rate, Merry Christmas and Happy Holidays to my readers. I'll be back later in December to rain on the bull parade.