One of Canada’s Big Six banks thinks it cracked the real estate price situation. BMO’s chief economist, Douglas Porter, wrote a recent analysis on the gap between Canadian and US home prices. As recently as 2017, he maintained many markets were in a bubble. However, he’s come to embrace the lack of affordability. The noted economist, concluded Canadians just pay more because they want to. He doesn’t believe it’s a misalignment of resources typical of a bubble either. Instead, he questions those that judge people who pay more, because it’s their preference. Uh… okay, let’s unpack this report.
Comparing Home Prices Using Purchasing Power Parity (PPP)
BMO used the purchasing power parity (PPP) exchange in their calculations. PPP is a comparison of the purchasing power of a currency, not just its exchange rate. To determine this, they compare what a “basket of goods” would cost in both currencies. Using PPP is popular with economists, because it helps adjust for local incomes. According to BMO, it’s been fairly consistent, and is currently an 0.83 ratio.
Canadian Home Prices Are 46% Higher Than In The US
Using this method, there’s a massive gap between Canadian and US home prices. In December, the seasonally adjusted average Canadian home was CA$617,000. In the US, this was just over US$350,000, or CA$420,000 after adjusting for PPP. The gap works out to Canadians paying 46% more than Americans, on average.
Just to confirm the absurdity, BMO’s chief economist decides to compare both by exchange rate anyway. Using Friday’s exchange rate, the average US home price is about $445,000. That still works out to over 40% higher. That’s with the Canadian dollar having advanced quite a bit since last year.
Most Reasons Commonly Attributed To The Gap Are Just Noise
Why the discrepancy? Well, the economist dives through common issues used to explain the gap. Lower interest rates in Canada? That’s offset by longer US amortizations. Canada’s urban concentration? That’s where incomes are stretched the most. He doesn’t mention Canada’s rural properties are more expensive than some US cities. However, that’s something we’ll dive into on another day. There is a ton more though.
Homeownership rates? US homeownership rates have recovered since the Great Recession. They’re now similar to Canada’s last reported levels. Tax treatment? Canada’s capital gains exemption is likely offset by US mortgage interest deduction. Population is the only argument with any real validity, due to immigration. He does believe this will be corrected with the new US government’s immigration reform. If none of those are the primary reason, what’s the deal?
BMO Thinks Canadians Just Enjoy Spending More
Porter thinks Canadian home prices are expensive because Canadians want them to be. The economist states Canadians may “…have made a collective choice to allocate more resources to housing than other countries.” He doesn’t however think that’s a “misalignment of resources,” as would be typical in a bubble. He further adds, “while some dismiss it as “consumption”, who is to judge if this type of consumption is better or worse than other forms of spending?”
In other words, a “Big Six” bank thinks spending more on real estate is just a national pastime. It not being a misallocation of resources, is an odd take though. If Canadians are spending 10 points more to service their mortgage, that’s money diverted from other aspects of consumption. By diverting this money from industries with higher GDP velocity, this puts a drag on GDP growth. Something that was falling on a per capita basis before the pandemic, many just didn’t notice.
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BAHAHAHA. Noted economist concludes irrational price premiums are rational in Canada. More at 6.
Fire him.
The difference between tax can not be dismissed. Canadians look at their homes as a retirement vehicle due to the tax free compounding of capital gains on a home. The Americans can write off interest on their mortgage, but this is not as significant as a tax free capital gain.
More marketing from the mortgage pushers disguised as economics.
What else can this fluff be called other than absurd?
In fact, no one ever willing spends more than they have to unless they have unlimited resources. Even then, big spenders are lured by conspicuous consumption like the Bugatti brand. They don’t spend the same on commodity transportation. To do otherwise could only express a mental illness, like willingly bankrupting yourself by sending all of your money to a scammer in Uganda for nothing in return. Since Canadians earnings are finite, not infinite, and we are not collectively mentally ill, the only other explanation would be to launder money from outside Canada or crime. I am sickened that a bank of that stature would propagate a ludicrous concept rather than address the real problem, whatever the problem may actually be. There must be money in it for them.
I respect Mr. Porters candor. It is not a strong economy or population. Basically nothing fundamental. Cheap money and psychology.
And he might not be wrong.
Real estate is definitely part of the value system of most Canadian at this point.
Try telling someone that real estate could lose money. They will respond I just made X and will think you have completely lost your mind.
It is going to take a lot to change the psychology.
But when it does….
Well said….cheap money and psychology……funnymentals….not fundamentals ….are driving the housing market.
Hey Sam, I don’t think its funnymentals – aka mental illness. It is the result of having no choice; home purchasers must compete in a false market. Markets that are driven by land-banking (foreign buyers shipping their money to safer havens i.e. Canadas attractive housing bubble) experience price increases that are detached from the local economy. Selling prices are designed to go up because it facilitates higher volume money laundering. ‘Sold Over Asking’ – the additional 10% creates more headroom for prices to increase ever higher. When our bubble pops and prices are dashed, at least the safe-havened funds were not fully confiscated in their homelands. Some is better than none.
Sadly, unless you benefited from the sale of an artificially inflated asset you cant buy an artificially inflated asset. And your kids, my kids, are all euchred (expletive deleted).
Our economy is eqivalent to the parable, The King has no cloths.
Until some brave economists stop denying how ridiculous markets have become and cry out the King has no cloths, this silliness will continue.
I agree Gerald. In 2015 Donald Trump said ‘I love the poorly educated!’ and without a hint of self-awareness they cheered back. They love him too.
I hope that BMO is not suggesting that Canadians are just as stupid. Possibly in this Giant Reset we-the-people can take back our monetary policies and banking systems for the betterment of everyone and not just a few.
Foreign ownership is a big problem. I’d like to see the stats, but it definitely inflates prices far above local economic fundamentals. I’m also sure corrupt organizations are using Canadian housing to launder money. Again, I’d like some stats to gauge the extent. However, in a democratic country ultimately it’s the people’s will that allows the status quo to continue. Why has the BOC, Government done so little to slow real estate down and bring it to a more reasonable climate of slow and steady, affordable growth? Ultimately I think Douglas Porter has it right. Canadians like it this way. It’s exciting, you can make a lot of money, it has been the main driver of GDP for years, house-owning Canadians are much richer in terms of equity accumulation….too many people really like the status quo. Too bad the the status quo is a recipe for a very difficult, prolonged and painful correction.
But no is actually richer, the numbers are just bigger. Like a $50 Big Mac.
Canadians pay more because they are forced to pay more and banks instead of saying NO, support by providing mortgage and more mortgage.
what is troubling is banks finance without validating income from revenue agencies.
Well, everything is more expensive in Canada. As an example, Sony wh1000xm4 headphones cost 500 CAD here while they cost 275 USD in US. On top of that premium, we pay additional 13% tax here in Canada. We also pay higher Income Taxes. You also have lower wages here. You have to be a complete retard to actually spend money on consumer goods in Canada.
I guess real estate is the only avenue to spend.
One of your best articles. Made me laugh out loud. Thanks for pointing out the hilarity of it all. Cheers!
It is obviously the land supply restrictions imposed by the formation of the Green belt is the prime cause for sky rocketing home prices. Whether it is justified to save the environment is entirely a different topic Land price is what makes up the price difference between a home in a big city and a home in a small town.
In Toronto
Have they ran out of rational lies?
Little exercise:
Wife&Husband in Toronto earn $210 000(top 10%). With monthly expenses of $3000
and down payment of $100 000 they can get a 850 000 mortgage (form TD) which will amount to $4033 monthly.
In Toronto a 2 bedroom shack on a noisy Isslington costs 1.3M.
So even if you enjoy overpaying for stuff, mathematically you can not afford a house you would be ashamed to show to your mother.
We enjoy overpaying?!! Are we all living in a dream of a guy overdosing on LSD?
People bought a home a few years back, ran up some debt, saw their house value increase, sold and bought to pay of debt and press reset.
i.e. bought at $550g in 2012 with a mortgage of $500g at 3.3% . Sold at $850g in 2019 and paid of $50g in debt. Then took $300g and bought new home at $800g with a mortgage of $500g.
They basically pressed the reset button……
so they downsized in 2019? did they move from a condo in Toronto to a townhouse in Pickering?