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Two bedrooms would be small for a house probably accounting for a significant overestimate though probably still on the high side. These days though, I wonder if the real concern should not be housing prices but income stability.

2009 prices were a blip:


Isn't a better measure the ratio of Average* Yearly Wage to Price? Overvalued, that is unaffordable, usually results when prices climb higher than three times the yearly average wage, IIRC.

*Mean, Median, whatever you want.

Last week-end, with my ex , I went visiting condos in Lévis, across the St-Laurent from Québec City. Apart that considering moving in with your ex for your retirement seeming a sane financial solution, 275K for a small two bedrooms in Lévis, with view on the school playground and full smell from the Ultramar refinery? If it is not a bubble, I must relearn english, rather charming british accent notwithstanding.
I am in the top 10% of the income scale, and my ex's small invalidity pension would add $ 30K to our "family" income. And still I don't see how we could afford those places. And I am not talking Jardins Mérici.

I'm under the impression that, rightly or wrongly, most people assess housing markets in terms of the ratio between rents and mortgage servicing (plus property taxes and maintenance costs, hopefully). So inevitably prices end up being higher when interest rates are lower, and will likely decline when interest rates go up.

I'm not sure if that means it's a speculative bubble, or just a change in fundamental market conditions.

If you value houses like a perpetuity, it makes sense that they would be quite sensitive to interest rates. Perhaps the long run up in house prices, especially over the last twenty years, is just a function of the steadily falling yield curve. Once/if the yield curve rises again, I would not be at all surprised to see a correction or stagnation in housing prices. It might take a few years for all the five year terms to roll over and the new reality to sink in.

There's lots of good blogs out there with lots of data (rp1 already linked to one above) so there's no need to start from zero on this stuff.

p/rent is probably the best measure, but p/income is also important (RBC puts out regular reports tracking this). In addition, it's important to try and gauge (physical) supply (i.e. new construction, not new listings) and demand as this can be a leading indicator of where rents will go (e.g. places like Australia and England where housing supply is weakly correlated with prices seem to end up with rising rents as a result, the U.S. not so much - Canada seems more like the U.S. but it's hard to know for sure).

It will be interesting to see what Carney has to say, it seems like most of his public comments on the issue have been along the lines of pressuring the feds into taking action (less CMHC insurance, shorter amortizations, higher down payment requirements, etc.) since he is hemmed in (from raising rates) by the need to keep the CAD low to avoid killing the manufacturing industry.

The price/rent indicator assumes that renting and owning are substitutes up to house characteristics. But it is not the case. Most people see high intrinsic value in owning there house. This might explain the above 25 ratios. But this is an issue of levels. In terms of percent changes, the numbers are still puzzling.

^ Even still, one would expect the effect of that intrinsic value of owning a house to be somewhat stable over time, and prices should continue to track rents at roughly the same multiple. The problem is that multiples have expanded significantly over the past decade. I don't buy that there has been a significant change in culture or values driving that change in valuation. It's a pretty huge premium to put on owning the house you live in.

Price to rent ratio is important because it indicates investor preference for real estate. Rental accommodation, from an investment perspective, should be treated no differently than any other asset class as, say, a stock is a completely viable alternate use of capital. The issue comes in when we mix the utility (rent) with the luxury (consumer surplus), and is why housing is so prone to speculative bubbles: the marginal buyer (and owner-occupier) is often willing and able to pay a premium over renting but eventually, since investor-landlords comprise 30% of the housing stock, investors will set the marginal price based on cash flows.

See my post http://housing-analysis.blogspot.com/2011/03/use-and-reasonably-foreseeable-misuse.html

Good blog jesse! (It's on the Canadian housing market). I've bookmarked it.

I'm not sure that comparing an average sale price with the average rent as reported by CMHC tells you much--at least not for Vancouver and likely some other larger cities.

The average sale price in Vancouver is currently being skewed by a lot of trading in the $2 million + range.

The CMHC average 2 bedroom rent is skewed by rent control. It's the average of what people are paying, and if they have been there for a while, they could be significantly under what that same unit would rent for today.

"average 2 bedroom rent is skewed by rent control"

Rent controls do not suppress rents, unless you can produce data to show otherwise. Rental growth has always been below the rent control cap from all the data I've seen.

Rent or income to price ratios can be extremely misleading indicators of "fundamental" house prices.

Consider a toy model. The no-arbitrage condition is that the marginal consumer is indifferent between renting and buying. If a house costs H and rents for R, the real interest rate is r, and m represents other costs (maintenance, taxes, etc) as a percent of H, then H and R are related by

H = R / (r + m),

ignoring expected appreciation or depreciation and transaction costs. Notice that the ratio of rents (or incomes, if we made the model a little more complicated) to housing prices depends critically on the real interest rate. For example, a house which rents for $2,000 per month and costs 2% per year in maintenance should sell for $480,000 at a real rate of 3% and $800,000 at a real rate of 1%. Also notice that the elasticity of prices to the real rate becomes larger in magnitude as r approaches zero.

Back of the envelope calculations suggest that the change in houses prices in Canada over the last decade is very roughly consistent with what we would expect from the simple equation above. In fact, since the real rate is currently hovering around zero, that equation suggests that prices should be even higher and more elastic to the real rate than we observe. Ed Glaeser has published a sequence of recent papers exploring dynamic models which can explain this lack of sensitivity as a result of expectations that real rates will rise in the future.

In short, tracking price to rent or price to income ratios to try to figure out if a housing market is in a bubble is not sufficient, as those ratios are endogenously determined and vary themselves as with supply and demand shocks even if we assume away bubbles. The most important shock to keep in mind when thinking about our current housing market is the real interest rate.

Once we move beyond toy models and recognize how important expectations and other hidden fundamentals may be in this market, I don't think any simple calculation is enough to determine whether we are currently likely to be in a bubble.

RBC does a study on affordability, which relates prices to wages - see http://www.rbc.com/economics/market/pdf/house.pdf

In January 2011 we sold our home. Once we did all the math, over 8 years of ownership, including all tax and expenses we lived in our home for free, and generated a 17% p.a. return on our equity investment. Initial loan to value was around 50%...so we are not talking excessive leverage. We did have a floating rate mortgage so we did take some interest rate change risk

This is an abnormal return on (low risk) investment, housing should not (and historically has not) generated that kind of return. Therefore, returns on housing investments will have to return to the mean. Carney spoke eloquently yesterday about the Canadian housing market, and said (as much as possible for the governor of the BoC) that the Canadian housing market was in a bubble.

@finance: Assuming that housing prices follow a mean-reverting process, noting that recent returns have been much higher than average implies we should expect lower returns in the future, but not necessarily negative returns. That is, we should not expect to see prices continue to climb as they have, but that doesn't mean they'll fall.

That's true in general, but in this case those high returns are likely largely attributable to changes in fundamentals, so it's not even obvious that unexplainable changes in housing prices have been higher than mean recently. It is those unexplainable changes that revert to mean, and they do so slowly---housing price shocks are not as persistent as they are in the stock market, but they are nonetheless very persistent. To a reasonable first approximation, we won't go far wrong if we pretend housing prices follow a random walk.

Carney pointed to large debts accumulated under low real interest rates and offered the concern that future increases in rates will decrease housing prices. That is an argument about fundamentals, not a claim that we're in a bubble about to burst. To the extent that some of his comments hinted he does think we're in a bubble, he's just guessing---no one, including the BoC, knows whether we're in a bubble.

Even if house prices don't fall, returns on housing have a high probability of being very low over the next decades.

"To the extent that some of his comments hinted he does think we're in a bubble"

In his position, Carney can't actually use the word bubble, instead he spelled out the dictionary definition of a bubble in his comment that, "one cannot totally discount the possibility that some pockets of the Canadian housing market are taking on characteristics of financial asset markets, where expectations can dominate underlying forces of supply and demand"

Basically he went as far as he could toward coming right out and calling it a bubble, given his position.

"Rental growth has always been below the rent control cap from all the data I've seen."

No way in Montreal for example, rents were slowed since the late 1990s by Qc laws. I think this "sticky rent" issue makes the use of P/rent problematic, at least over relatively short periods (say 10 years) and when comparisons are made across markets (where rent control laws can differ a lot). A forward-looking home buyer may realize that today renting is a better deal, but that in 5-10 years rents will have caught up.

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