Canadian Estate Prices Are The Most Overvalued In the G7, Shows Another Indicator

Canadian real estate prices are the most overvalued in the G7, measured against rents. IMF data shows Canada’s house price-to-rent ratio in Q2 2020 was the highest of any G7 country. The indicator is commonly used by analysts and economists to determine stretched valuations. Home prices across the G7 have grown faster than rents on average. In Canada however, they grew nearly twice as fast as the average, over just a few years.

House Price-To-Rent Ratio

The house price-to-rent (PTR) ratio is the ratio of home prices to annualized rent. It’s often used as a benchmark to figure out if it’s cheaper to rent or own. More important, analysts often use it to figure out if homes are overvalued for a market. 

Rental costs are closely tied to wages, with growth limited to what local incomes can support. You can’t easily charge a whole country 20% more rent, if wages are only growing at 2-3%. Home prices however, reflect how much credit the marginal buyer is able to consume. If home prices rise much more than rent, it’s often due to easy credit conditions — not fundamentals.

The IMF uses an indexed approach for tracking the change. They set 2015 as the base year with a value of 100. If the index rises, it means house prices increased faster than rents. If the gap between home prices and rent increases, the index value rises. If the gap between the two closes, the index value falls.

It’s worth stressing once again, the base year of 2015 is set at 100. It gives the impression that 2015 had the correct price ratio, but doesn’t really mean that. Inefficiencies may have started way before that date, and persist to this day. However, we’re going to be mostly talking about how much things have changed since that year.

Canadian Home Prices Grew 28% Faster Than Rent

The Canadian PTR is the highest of any of the G7 countries, with prices rising much faster than rents. Canada comes in at 128.0 for its latest period, which is Q2 2020. This means the gap between home prices and rents grew 28% since 2015. Also worth mentioning, the data is for Q2 2020. Home prices really took off after that quarter, especially in small cities and towns. The disconnect is most likely much larger at this point.

G7 House Price-To-Rent Ratio

The index value of house price-to-rent ratios, with 2015 set at the base year of 100.
Source: IMF; Better Dwelling.

US residential real estate is experiencing a similar trend, but not to the extent seen in Canada. US home prices had a PTR of 110.6 for Q2 2020. Home prices saw 10% more growth than rental prices. Canadian home prices accelerated faster than rents, at over twice the rate as the US. Canada is an outlier not just compared to the US, but also compared to other G7 countries.

The Canadian Gap Between Home Prices and Rents Increased The Fastest In The G7

The gap between Canadian home prices and rents, is the fastest growing in the G7. Germany, the second highest PTR ratio in the G7, is 2.1 points lower than Canada. The average G7 PTR ratio is 13.9 points lower than Canada. The Canadian gap grew twice as fast as the average of all G7 countries. 

The Canadian home price-to-rent ratio is the most extended of any of the G7 advanced economies. Since the latest data is Q2 2020, this ratio is also likely to have accelerated even further by now. A lot faster, considering prices are now soaring, even in small towns.

Typically a disconnect between home prices and rents is corrected. Any combination of home prices falling, or rents rising would fix it. When the gap is this big though, it’s hard for rent prices to close the gap by much. If it made a big jump in any reasonable amount of time, it would create inflationary pressures for wages. Wages accelerating to handle rising living expenses is an economy’s death sentence.

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  • Jamie 3 years ago

    Everyone in Canada thinks their home price will rise 10 to 20% every year from now one. It’s a wild time to be located here. Just 10 years ago, everyone in Vancouver was talking about starting a business. Now they’re all positive just owning a condo will be income security forever.

    • RW 3 years ago

      Just 20%? My neighbor is convinced his home is going to rise 30% per year, “because Trudeau works for the banks.” We won the lottery, and somehow people now think they’ll be lottery winners every year.

  • Han Thanh 3 years ago

    Sure, but then you’d have to rent and everyone in Canada will think you’re as poor as the bank executives that do.

  • HotRod Honno 3 years ago

    This is inflation and lack of building. You can try any other argument or blame any group or ethnicity but you are a failure because you do not understand that when the cynical, deceitful, dishonest govts. at all levels reduce the purchasing power of money when they simply print more of it, it then loses value and loses confidence. That is why housing (and EVERYTHING else) is going up in price.

  • SmugCanadian 3 years ago

    How do we get rid our Bank of Canada governor?? It was so irresponsible of him to tell the country they had no plans to touch rates until 2023!!! Talk about throwing lighter fluid on a bonfire!!! What a moron!!!

    • jim 3 years ago

      Incompetency at that magnitude should be a crime. BOC will just waffle on about the issue, give it a positive spin, or deny responsibility.

    • Ashley 3 years ago

      You’ll need to be friends with Tim Hudak and Brad Lambs to get him replaced with your choice of BoC governor. Maybe even federal cabinet, since real estate is what runs this country.

    • John Thunder 3 years ago

      The entire rest of the world has also done this…

  • World Class 3 years ago

    Echoing the comments made above – no government or Central Bank (which are all highly political now) will touch any levers to bring housing down as the majority of the population owns housing (and increasingly multiple houses/condos). By cooling down the market you will impact the vast majority of people’s net worth. Voters talk progressive politics, they vote with their net worth.

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