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Canadian Real Estate Prices Will Fall 28% By 2020 According To This Model

Canadian Real Estate Prices Will Fall 28% By 2020 According To This Model

We get a few dozen emails weekly asking where we think Canadian real estate prices are going to be in the next few years. We can’t see the future (yet), but we can help you understand some of the financial models used to hypothesize these things. Today we’ll use the Organisation for Economic Co-operation and Development (OECD) House Price-To-Rent Index, and a linear regression model. This method predicts Canadian real estate prices will fall 28% by 2020.

OECD House Price-To-Rent Index

The House Price-To-Rent Index is a measure that compares the cost of ownership to the price of renting. If your rental yield is high, why would you sell your property for a discount? Likewise, if you can rent a property much cheaper, why would you pay more to buy it? Rent is a pretty good indicator of value, especially in large cities. If you’re thinking “but I’m not going to rent the property out!,” think of yourself as your own tenant.

To get the number, they take the cost of renting annually, and compare it to the cost of carrying a mortgage for a year. When the index shows a breakaway from the norm, home prices will come down or rents will come up. Rents are limited to income growth of the population however, so it’s hard to raise rent quickly. It happens, but it’s less likely unless the rest of the economy is in hyperdrive and pay is quickly rising.

Regression Modeling

Before we get to the numbers, let’s quickly run through what is a regression model. When a variable hits an extreme high or low, it will then move progressively closer to the mean line. A regression model is one that theorizes where that mean line will be. Like all forms of statistical analysis, it’s definitely not 100% accurate. It does provide an educated baseline to figure out where things are heading.

In matters of money however, it tends to be more accurate. Jason Zweig, an editor at the Wall Street Journal once famously said “regression to the mean is the most powerful law in financial physics. Periods of above-average performance are inevitably followed by below-average returns, and bad times inevitably set the stage for surprisingly good performance.” Whether this is a self-fulfilling prophecy is up for debate, but the point is it’s worth running the numbers.

Canadian Real Estate Prices To Drop 28%

There’s a few models we could be using, some are much more complicated than others. Today we’ll stick to your basic trendline using exponential linear regression. Using this model, and using the OECD index numbers, we should see prices drop by 28% by 2020.

Source: OECD, Author’s Calculations.

You won’t necessarily see a 28% reduction in sticker value. Inflation will likely decrease the value of money, and reduce the drop by 2% per year if the Bank of Canada can consistently hit their target going forward. It is a pretty big drop, but not a lot of people could have predicted the big climb either.

Using This Model For The Toronto’s Last Crash

Backtesting these numbers, we can see this method isn’t perfect. Using Toronto as the example, at the peak hit in 1989, the model predicted a 26.6% decline of average prices by 1993. By 1993, average sale prices were only down by 24.55%. It wasn’t until 1996 that prices declined 27% from the 1989 peak, before reversing. Not every model is perfect, but for such a relatively simple model – I think it did a fantastic job.

It Doesn’t Have To Drop 28%

There is another option rather than prices dropping 28%, rents can soar. If rents increase by 39% by 2020, we once again have a balanced market. This is less likely due to the fact that rent increases are tied to income increases, but it could happen. More likely a combination of the two will occur to help balance things out.

No one can tell the future with 100% certainty. However, big money investors use well-established models like these to make decisions. The fact that decisions are made on these numbers by such a large group of people, likely does make it a self-fullfilling prophecy in my humble opinion. We’ll be running more complicated models in the future. If you’re in Toronto, you might want to brush up on the inverse relationship between rent and home prices in the meantime.

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19 Comments

  • Reply
    DPMc 3 weeks ago

    What this model misses is the impact of rising prices on an investor’s decisions. I live in Richmond BC, and many of the investment properties are not even rented out at all. And I myself have held onto properties with a negative cash flow, because the increasing value outweighed the month-to-month loss. The rental income is only one part of the equation. It may be true that prices will drop by 2020. Or they may rise. Over the last couple decades I’ve watched lots of people who are betting on a crash drop further and further behind.

    • Reply
      Bay Street Guy 3 weeks ago

      “Over the last couple decades I’ve watched lots of people who are betting on a crash drop further and further behind.”

      There’s the problem with real estate investors that hold properties with losing carrying costs. They assume everyone else is just waiting to buy property, no other investments in hand. You made one year where prices increased 30%, I made 10 years where the money I’ve managed has averaged a 17% annual return. You hit the lottery once, investors that utilize their capital for exponential gains still end up at this point.

      The cost of carrying a mortgage is probably the rate of rent that most people pay if they’ve been in a purpose built rental for the past 5 years. Buying a house isn’t an investment, I don’t know why Canadians don’t understand this.

      • Reply
        Just My Opinion 2 weeks ago

        Bay Street Guy, its nice that you can make up to 17% annual return. In most cases people don’t have the professionalism like you do or they are not willing to take as big of a risk.
        Also 30% is not considering leverage which most real estate investments are usually around 50%. Yes there is interest cost to it as well but if they property is rented out then most of the time it is offset and may even bring positive cash-flow.
        Yes real estate investments have risk but generally speaking, it is safer and less risky then most other types. If you look at the price over the years it beats inflation by a decent amount.
        Also I do agree that it is unlikely for it to increase as rapidly in the future but a steady 5% annual appreciation is likely plus the rental income. It’s a decent investment for retired people.

    • Reply
      Josh 3 weeks ago

      Just gonna pop in here to say eff you for sitting on a property and not renting it out. You want investments – buy stocks. Not homes. You’re a huge part of the problem.

      • Reply
        Lewis 3 weeks ago

        “Just gonna pop in here to say eff you for sitting on a property and not renting it out. ”

        Could be wrong, but I think since they said negative cashflow, they meant they’re renting it out at a loss?

        Regarding all of the people that have just left homes empty, yeah…they basically ruined the market for themselves. They have homes worth a ton, but pretty much no liquidity. Who’s going to buy a $3M bungalow? Other investors, and possibly speculators. That’s pretty much it.

  • Reply
    Michael Z. 3 weeks ago

    I like the humbleness. If this was a certain other real estate blog, the fact that it hit the number in Toronto with 98% accuracy – it would be doom and gloom time. You’re right though, a crash is 100% dependent on people not expecting it. If people expect it, it doesn’t crash. Duh.

  • Reply
    RE Bear 3 weeks ago

    I’m more comfortable with a 28% crash than the 50% Marc Cohodes has been saying. That guy’s been right about a lot of things, but he never shows his work. I never know what to make of it. Great job btw.

    • Reply
      Glynis Van Steen 3 weeks ago

      Marc Cohodes should stick with his chicken farming…his comments about Canadian financial markets prove that he doesn’t really “get” the Canadian scene.

  • Reply
    Jim 3 weeks ago

    I’m not suggesting this market and these price are sustainable by any stretch of the imagination. But I’m not convinced technical or chart analysis is all that credible. A graph is simply a score card.
    I would look to interest rates- about to go up, population growth- declining ex immigration, and housing mix- shrinking average owner occupied . Rental incomes are, of course, an expense as well. Rental costs are a lagging indicator.
    Price will go then down, then up then down. It has always been thus.

    • Reply
      Lewis 3 weeks ago

      Pretty sure that’s what they meant when they said a “simple analysis.” Although the author is underselling the importance of these numbers.

      I’m not sure if you’re aware, but those things are factored into rents and home prices. The reason a house price-to-rent ratio is used is to find out how out of whack prices are to the value they can actually get when being used.

      Notice that all of the dips in the chart align with huge economic booms in Canadian history. These are points where rents *could* go up, bringing the price-to-rent index down. They’re also mark the pop of real estate bubbles across the country, since a well-paid workforce needs to stay mobile to move where the money is. They don’t buy.

  • Reply
    Allen 2 weeks ago

    Minimum wage raising more than 30% in Ontario. Other provinces to follow. Rents will easily go up as inflation is unavoidable.

    • Reply
      Neo 2 weeks ago

      Allen,

      A minimum wage job in 2019 will pay you $31,200 a year or $2,600 a month. That is still peanuts in the GTA to buy or rent and we are still two years away from that $15/hour. Sure, in the outskirts of Ontario you can make a go of it but they can make a go of it now for the most part.

  • Reply
    Frank Mcknight 2 weeks ago

    Re Rent to Prices Index: Sure but. Whereas, the reality is, if people want to rent something, for a variety of reasons, then capital has to be invested, by either individuals, or corporations, or government. And that capital investment, (even if it is government, who borrow the money), requires interest/return on the investment. If we don’t have a return, then look what happened since 2008 with easy and cheap money.

    Also, the reality is, if the rental income is less than the damages, and hassle, and legal bills, and accelerated depreciation, and general cost of renting, and even a low cost of capital, then who would invest to rent. Corporations won’t without taxpayer subsidies; so why would individuals.

    Vancouver’s and Toronto’s mayors are delusional, when they say they will add rental units by banning STVR. (Other STVR planning issues aside). Because, the reality is, they cannot force individual investors to lose money. Same for taxing vacant properties. When is it acceptable to demand, or penalize, resident and Canadian individual owners, to lose even more money by renting units out; l must have missed that memo.

    And likely, for these mayors, and for sure other levels of governments too, it is okay that locals have to compete with the international globalization of Cdn real estate. And for sure, their intent, with banning STVR, is to drive even more for-profit rental units, from individual investors, into either corporate hotels, or “taxpayer-subsidized-for-big-profit-and-for-big-salaries-corporate” rental housing.

    Whereas the reality is – gov’t could turn out, at zero-cost to tax payers, not for profit, and not with big salaries guarantees either, low income rental or ownership housing, if they wanted too; (see Whistler model, or habitat for humanity, or co-ops, many other models too).

    Also, a lot of people, about 1% to 10% of people, worldwide especially, got bat-shit-crazy-very-rich from the winners-take-all, (and whole pile of losers to pay for it), pied-piper government policies of free-trade, globalization, perpetual wars, massive debt enabling everywhere, financialization, monetization, etc,. And those now many of those phenomenally rich people are cashing out, to buy their sweet slice of a resort and tax haven paradise. And Canada happens to be one of the very few places that meet those criteria. And good news too, thanks to gov’t policy, Cdn RE is also freely available on the open global market.

    Finally, as in so many other articles too, some people have such unconsidered blame-bias to their housing affordability issue:
    * For Canadian individual RE investors – these are totally bad people – so let’s name and shame and “fee/tax/hassle” them to hell and back.
    Mean While:
    * For corporation who refuse to pay a living wage = they are not culpable
    * For big profit, with huge CEO salaried corporations, that have low taxation and yet still demand tax evasion opportunities, and guaranteed profits on PP3’s, and then demand tax payer subsidizes, handouts, and profit guarantees to add to the party mix = they are not culpable
    * For Gov’t that willingly participate as corporate wealth managers by gushing out tax payer subsidies, and handouts, and profit guarantees, and monopoly like access = they are not culpable
    * Gov’t who promote the sale of Canadian property to foreign interests (without benefits to Cdn, and especially often with negative tradeoffs) = they are not culpable
    * Big banks who make billions on billions, and their CEO’s who make millions on millions, from profiting on government-guaranteed-profits on mortgages = they are not culpable
    * For irresponsible tenants who don’t pay for their damages, skip out on paying rent, and hassle owners, and generally contribute to the shortage of rentals = they are not culpable
    * For the gov’t that has failed for decades to take up affordable housing policies, at zero cost to tax payers, by orchestrating the availability of land at cost before zoning changes and transit investments, the removal of profits and huge salaries, and thereby creating some low income home-sales-and-rentals at cost = they are not culpable

    Meanwhile, brute self interest and corporate tribalism, and gov’t operating as wealth managers for the 1%’ers, (ironically while 92% of the cost of running gov’t is from low to mid income taxpayers), is all doing just very well, thank you for asking.

  • Reply
    MICHAEL S. CORRELL 2 weeks ago

    Maybe if owners are leaving houses empty squatting should be allowed? I’m sure that would move the market along and be a great help to our poor homeless brethren, as is our Christian duty.

  • Reply
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