This is the question on many Canadian homeowners’ lips lately. Toronto home prices, for instance, have risen steadily over the past 12 months. This is in stark contrast to the acute housing problems in the US, so it is natural to question the fundamentals behind rising Canadian home prices. Many analysts are screaming ‘bubble’.
To ponder this, I dug into some Vanier Institute of the Family, Scotia Capital and RBC Economics research. Let’s walk through the findings as if I am the decision maker responsible for a small family looking for a place to live.
1. Do I rent or buy? This is determined by the relative cost. According to the first chart below, the relative cost of ownership is declining. Although the chart doesn’t show this, anecdotal evidence suggests the relative $ costs of renting vs. owning are fairly similar. The decision may tip to ownership, but either alternative is likely reasonable.
2. Can I afford a mortgage? As a proportion of income, home ownership has become more affordable over the past couple years. However, it is somewhat higher than bottoms found during the early 2000s. On the other hand, affordability is comfortably better than at the peak of the last real estate bubble that burst in 1990. Housing affordability appears fair.
UPDATE: Although affordability based on monthly ownership costs (above graph) is close to average, the overall home price-to-income ratio is quite high (graph below). Is home price-to-incomes ratio a good indicator? Probably not since the home price-to-income ratio was below average in 1990, which was the peak of the last real estate bubble in Canada – this suggests that monthly carrying costs are more important than the overall ticket price. However, carrying costs will be negatively impacted if mortgage rates rise significantly.
3. Do I have bargaining power? If there’s tons of supply, I will play the field until I get a good deal on a house. Again, inventories are above the early-2000s bottom, but well below the 1990 peak. Housing supply appears reasonably scarce so I am less likely to wait around for a good deal. In fact, I may be competing with other families forcing me to jump on the first house that suits my needs. [Scarcity - especially in basic needs, such as food and housing - causes people to fight for remaining supplies, rather than wait for more supplies to come to market.]
4. Do I expect housing supply to come on the market in the near future? If I was looking for a residence, but knew that tons of supply would be flooding the market in 12-18 months, putting pressure on prices, I might be tempted to delay my purchase. Rising mortgages in arrears signals that supply may rise in the future (due to short sales, foreclosures, etc.). While the graph below appears daunting, the scale on the left shows that the rise is quite small. Also, most people wouldn’t because they tend to make decisions based on immediate observations. But rational buyers might wait.
So would I buy? There doesn’t appear to be compelling evidence that Canadian real estate overall is in the final throes of a bubble. Different cities will have different dynamics, but overall the buy decision doesn’t appear irrational. While housing prices may be expensive, it doesn’t appear that we are near the peak of a housing bubble. However, rising interest rates, a flood of supply, cheaper rent or large job losses could change the outlook for Canadian real estate prices.
Sources: Scotia Capital and RBC Economics and Vanier Institute of the Family
