Canadian Home Prices Make The 2006 US Real Estate Bubble Look Like A Deal

Canadian real estate is receiving a big warning sign from an indicator that was an alarm for the US in 2006. The house price-to-rent ratio shows Canadian real estate is overvalued. When contrasted to the US is when you really get a feel for how much Canada went all-in on real estate. It makes 2006 America look like a sleepy backwater market of value investors.

House Price-To-Rent Ratio

The house price-to-rent ratio is an indicator used to gauge overvaluation. It compares the cost of a home to the cost of renting a similar place. Since rent is a fundamental indicator tied close to income growth, it tends to be mostly stable over time. That is, it reflects a change in earnings or productivity. As opposed to home prices, which mostly reflect access to credit.

When home prices grow faster than rents, it means valuations are becoming stretched. Persistent growth means prices are becoming overvalued. US economists feel this was one of the most obvious signs of the housing bubble in 2006, in hindsight.

When the ratio falls, it means home prices are becoming more fairly valued. If it persistently falls, it can mean home prices are becoming undervalued. In a healthy market, the price-to-rent ratio would move relatively horizontal.

Today we’ll be looking at the indexed values, which help to allow multi-country comparison. When looking at the indexed value, you’re looking for the change over time, instead of the actual number. What you don’t want to see is persistent and high growth. That would mean the market is becoming overvalued.

Canadian Home Prices Grew 107% Faster Than Rent Since 2005

Canadian home prices have grown much faster than rental prices, indicating significant overvaluation. The index increased 7.7% in Q4 2020, compared to the same quarter a year before. This means home prices accelerated 7.7% faster than rents over the same period. It’s also 36.0% higher than it was in 2015 as well. This is a significant detachment from fundamentals, and a steep premium to own vs rent.

Canadian House Price-To-Rent Ratio

The indexed quarterly value of Canada’s house price-to-rent ratio from Q1 1970 to Q4 2020.
Source: OECD; Better Dwelling.

Although this is a long-term trend for Canadians.  The index has increased 107% since 2005. On a much longer scale, the index has increased 574% since 1970. Home prices have been rising at a breakneck speed for almost 50 years. Looking at the chart though, you can see it really starts breaking away in the early 2000s. The index almost triples over just the most recent 20 years.

When looked at by itself without context, these kinds of numbers may seem normal. What’s it supposed to look like? Let’s check out how Canada’s closest neighbor looks. After all, they have extensive experience with overvaluation.

US Home Prices Grew 1% Slower Than Rent Since 2005

The US has also had a big year for home prices growing faster than rents. It actually saw larger growth than Canada. The index increased 8.1% in Q4 2020 when compared to the same quarter a year before. It is also 26% higher than it was in 2015, so it’s had some decent growth over that period. The growth over the past 5 years is still only three-quarters of that seen in Canada. Even more interesting is how this looks over a much longer term.

US House Price-To-Rent Ratio

The indexed quarterly value of the US house price-to-rent ratio from Q1 1970 to Q4 2020.
Source: OECD; Better Dwelling.

The long-term trend looks totally different from Canada over the past few decades. The index is actually down 1.5% from 2005. To rent is a little more expensive than to buy, compared to just before the Great Recession. On a much longer basis, the index is only up 26% from 1970. Once again, home prices have accelerated in growth more than rents, but not nearly as much as in Canada. The trend is almost horizontal.

The overvaluation of Canadian real estate based on rent is much higher than US real estate. Over the past year appears to be a bit of an exception. The American price-to-rent ratio grew a point faster than Canada’s ratio. That seems to be one of the few times it has happened in the past few decades.

In general, Canadian home prices grew faster than rents. From 2005, Candian home prices grew 105.7 points faster than the US. Since 1970, it’s about 21 times faster. This is one of those things that’s easier to understand as a chart.

Canadian and U.S. House Price-To-Rent Ratio

The indexed quarterly value of Canadian and US house price-to-rent ratio from Q1 1970 to Q4 2020.
Source: OECD; Better Dwelling.

The Canadian line looks like persistent growth, all the way through. This indicates home prices have grown much faster than rental prices. It’s not until Canada enters the early 2000s, when it really starts to take off though. 

There is a brief moment around 2008, where it pauses, before going for a second run higher. Home prices are now far in excess of what rental prices can support. In hot markets, private landlords subsidize rent. That’s because home prices are growing so fast, who cares what the rent collected is? You more than likely plan on kicking the tenant out in a few months, and collecting your capital anyway.

The US price-to-rent ratio is more cyclical in contrast, with spikes during bubbles. It also tends to form a trough during recessions, allowing for value balancing. Home price overvaluation can be seen, just not to the same extent as Canada.

The price-to-rent ratio is another fundamental indicator showing questionable valuations. Like disposable income, this highlights fundamentals lag the US on a long-term basis. Despite the US being notoriously expensive, it’s actually much more affordable than Canada. Even so, you would be hard-pressed to find a Canadian that thinks home prices can fall anytime in the near future.

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  • Trader Jim 11 months ago

    Blows the interest rate argument out of the water, since both countries are mostly zero bound and have been for a while.

    Unhealthy growth of home prices for sure, but I think few people would argue that other than those with a vested interest.

    • Kath 11 months ago

      “Blows the interest rate argument out of the water, since both countries are mostly zero bound and have been for a while. ”

      What theory is that exactly? Are you saying that Canadian house prices would still be as high as they are even if interest rates had not been exceedingly low for so long? Surely you jest.

      • Oops 11 months ago

        Yeah but does Canada really have a choice in these matters? We follow the US FED.

  • christian 11 months ago

    Very good article. Thanks Mr. Wong.

  • Mtl_matt 11 months ago

    Landlords are trying to fix those graphs. By jacking up the rents.

  • Catherine 11 months ago

    I think you forgot to take interest rate into account.
    Whereas in the US the mortgage rate is around 3.5%, in Canada you look at completely different numbers.
    Maybe you want to add an additional graph. I guess we will still see a gap, but much smaller.

    • Nassim 11 months ago

      Yes, the OECD forgot to take into account interest rates, which a random person on the internet caught. The interest rates only apply to Canada as well it would seem, since the point of the article is a cross-country comparison.

  • DAR 11 months ago

    Price to rent ratio seems to me to be a meaningless indicator of housing affordability. In regard to affordability , what matters more than price is the monthly carrying costs. In today’s low interest rate environment, the monthly carrying costs of a high-priced house are very low.
    Why are analysts still slavishly writing articles about this meaningless indicator?
    Why are they not comparing monthly carrying costs of buying vs. renting?

    • Nassim 11 months ago

      It would seem that way if you don’t realize that it’s based on carrying costs.

    • SomeMillenial 11 months ago

      Because interest rate risk has become worrying, having a low interest rate environment is not set in stone, and rates will have to rise at some point, either that or inflation.

    • Kath 11 months ago

      Price to rent ratio is more a measure of house price over-valuation than it is of house price affordability. Mortgage rates are a measure of affordability because as you say, most people only care about the monthly cost.

    • Paul 11 months ago

      They are writing and posting almost every day right now.

      Why don’t you write about it?

      Also they have. This is a blog which means it’s archived so why don’t you look back in time and read some of the previous articles. They are enlightening.

  • JAVAID KHAN 11 months ago

    The way home prices went up with low interest rate every day even in pandemic clearly shows manipulation of market, also no interference from government in the name of free economy raise the doubt.

  • questions guy 11 months ago

    the chart is bonkers… I don’t see a dip for Canada in the 90s… maybe regraph using 2000 as the starting point?

    also, Canadian housing is free of tax, where the US treats housing like any other asset – maybe that’s the real reason for the absurd growth

  • Sean 11 months ago

    Tax free on sale. Mortgages backed by the government. We put policies in place to reduce risk. The money just follows that. Until it stops and the cascade begins. Don’t think anyone expected us to get this out of balance though.

  • Dave McGruer 11 months ago

    Seems to agree with my analysis, which looks at each purchase like an investment – as if you were buying the property as a rental unit. I have found in Ottawa that prices are 30% to 40% higher than justified by reasonable market rental rates. Assume you want an 8% return of investment, factor in the various carrying costs including capital cost, then see how the math works on the investment opportunity.

    • questions guy 11 months ago

      landlords are subsidizing renters… renting is a deal!

Comments are closed.