The IMF Crunched Numbers On Canadian Real Estate. Here’s How Overpriced It Is

Canadian real estate prices are soaring, but only a few markets have detached from reality. The ones that have though, boy oh boy – have they ever detached. New numbers obtained from IMF staff, show the gap between prices and fundamentals. For the most part, Canadian real estate prices can be explained through access to easy credit. Hamilton, Toronto, and Vancouver are notable exceptions, and may be 50% overvalued.

About The Numbers

Today’s numbers are split into observed aggregates, and “attainable” prices. The observed aggregate is a fancy way of saying indexed or benchmark. It’s an index of home prices, not unlike the Teranet-National Bank HPI, or CREA benchmark. It’s the price of a typical home in each respective market. These are based on the prices paid in each quarter.

The attainable price is the price of a home, if it was supported by fundamentals. IMF staff used a static borrowing capacity (SBC) model to determine this. An SBC model is based on how much a household can afford based on income, mortgage rates, and leverage. To be blunt, it’s the price the broad market can support. Prices in most CMAs, up to last year, could be explained largely by borrowing capacity. Notable exceptions exist in Hamilton, Toronto, and Vancouver.

Marginal Buyers, Sellers, and Liquidity

Now, your real estate agent probably just appeared behind you in a puff of smoke – not unlike a magician. They’re probably whispering, “the price someone pays, is the price of a home.” Or even, “tight supply is why home prices are more expensive.” This is true – to an extent. However, the price is mostly influenced by the marginal buyer.

The marginal buyer is the small group of people that set the price for a market on the way up. In a market with scarce inventory, someone pays a premium to get a home today, making them a marginal buyer. These buyers aren’t rational, but they drive price all the way up to the peak. Since the market will use this as a comparable, it influences the whole market. I’ve touched on this in detail before, when explaining why money laundering distorts real estate prices. It’s the same thing, so I won’t spend too much time on it. However, the point is, the observed price is a relatively small number, projected to a whole market.

The opposite also exists, which is the marginal seller. They drive prices down. This is a motivated seller, that everyone else has to race to the bottom. Generally these only appear when a liquidity event occurs. Recession, rising unemployment, falling asset prices, or tighter lending are common causes. These don’t last for long, but they are very quick.

Fundamental prices are neither set by the marginal buyer or the seller. Instead, it’s the price of a home based on long-term demand factors, and what the market can continually support paying. That’s through recession, upturns, and downturns. Generally speaking, market (or observed) prices are often above or below this level.

Toronto Real Estate Is Over 54% Higher Than Fundamentals

Toronto real estate has a massive gap between observed and attainable prices. The observed price was $856,003 in Q3 2018, down 3.1% from a year before. The attainable price in the same quarter was $553,467, down 3.6% from the year before. That places the last observed price 54.7% higher than attainable. Toronto has the second largest price gap in the country. Most of Toronto’s gap could be explained by credit growth, until about 2015. This is when things started to really disconnect.

Toronto Real Estate Price Affordability

Toronto real estate prices, compared to attainable fundamental prices.

Source: Statistics Canada, CMHC, Haver Analytics, Real Property Solutions, LLC., Teranet, IMF, Better Dwelling.

Vancouver Real Estate Is Over 51% Higher Than Fundamentals

Pricier Vancouver apparently is a little better than Toronto, but not much. The observed attainable price was $1,134,157 in Q3 2018, up 1.6% from a year before. The attainable price fell to $749,505, down 3.6% over the same period. The gap is over 51.3% between observed and attainable prices. Vancouver has the third biggest disconnect in Canada.

Vancouver Real Estate Price Affordability

Vancouver real estate prices, compared to attainable fundamental prices.

Source: Statistics Canada, CMHC, Haver Analytics, Real Property Solutions, LLC., Teranet, IMF, Better Dwelling.

Hamilton Real Estate Is 57% Higher Than Fundamentals

Hamilton is the king of disconnected real estate fundamentals in Canada. The observable price reached $540,077 in Q3 2018, up 3.1% from a year before. The attainable price hit $343,736, falling 3.6% over the same period. The gap between the two is a massive 57.1%, the highest in Canada.

Hamilton Real Estate Price Affordability

Hamilton real estate prices, compared to attainable fundamental prices.

Source: Statistics Canada, CMHC, Haver Analytics, Real Property Solutions, LLC., Teranet, IMF, Better Dwelling.

Montreal Real Estate Is 9% Higher Than Fundamentals

Montreal real estate has a more reasonable gap between observed and attainable prices. The observed price reached $414,907 in Q3 2018, up 5.7% from a year before. The attainable price reached $379,952, falling 3.6% over the same period. The gap between the two is just 9.2%, big – but not all that big. This is more indicative of a minor deviation from favorable financing conditions.

Montreal Real Estate Price Affordability

Montreal real estate prices, compared to attainable fundamental prices.

Source: Statistics Canada, CMHC, Haver Analytics, Real Property Solutions, LLC., Teranet, IMF, Better Dwelling.

Victoria Real Estate Is Over 22% Higher Than Fundamentals

Victoria real estate is pretty rough, but the gap looks tiny in contrast to the other cities. The observed price was $809,930 in Q3 2018, up 6.8% from a year before. The attainable price fell to $660,795, down 3.6% over the same period. Observed prices are 22.6% higher than attainable prices. Seems not that far in contrast, but make no mistake – that’s a big number when it comes to money.

Victoria Real Estate Price Affordability

Victoria real estate prices, compared to attainable fundamental prices.

Source: Statistics Canada, CMHC, Haver Analytics, Real Property Solutions, LLC., Teranet, IMF, Better Dwelling.

Calgary Real Estate Is Over 8% Higher Than Fundamentals

Calgary real estate prices are barely rising, but affordability is deteriorating. The observed price hit $507,303 in Q3 2018, up just 0.5% from a year before. The attainable price fell to $469,538, down 3.6% over the same period. Observed prices are 8.0% higher than attainable, most of which happened due to rising rates.

Calgary Real Estate Price Affordability

Calgary real estate prices, compared to attainable fundamental prices.

Source: Statistics Canada, CMHC, Haver Analytics, Real Property Solutions, LLC., Teranet, IMF, Better Dwelling.

Here’s how Canada’s other cities stack up.

Canadian Real Estate Prices Vs. Fundamentals

The percent difference between observed prices in Q3 2018, versus attainable fundamental prices by market.

Source: Statistics Canada, CMHC, Haver Analytics, Real Property Solutions, LLC., Teranet, IMF, Better Dwelling.

Generally, a distortion doesn’t persist for a long time – but it probably feels that way. A price correction isn’t the only way for the gap to be closed. A combination of income rising, credit loosening, and more leverage can be used. This of course results in other issues, especially since the gap is only visible in 3 or 4 markets. It also leads to a permanent market distortion to make either of those changes. However, politicians and central bankers only think four years at a time.

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  • Marc 5 years ago

    Combine this with rising fixed and variable rates, and that attainability line is shrinking by the day.

    • Mike 5 years ago

      We are one major catalyst away from prices dropping. This is not sustainable. Businesses will move out of the city cause cost of real estate and salaries will be so high. Most Business is done virtually today, no need for higher expenses in a major city. People will move out further from cores of toronto and Vancouver to maximize quality of life.

      Job replacement with machines and a global slowdown are two major issues in our future. This will harms many people and push them to the sidelines of ownership.

      At some point in time wealthy people with wealthy assets will have to let others in on ownership or they can’t continue to grow. We live in awkward times with such division of wealth clearly growing but the system also arms the wealthy cause they need consumers. Hence why we are entering negative rate territory and pretty soon will be punished if we save money and incentivized to spend more and more. What a broken ass system. I have enough capital to retire in Thailand on a beach right now in my 30s but can’t even afford a home here in toronto. What are we chasing to be happy? People will wake up.

  • Lucas Seq 5 years ago

    Sure, but what training does the IMF have on prices? My Realtor took a whole weekend class to get his qualifications.

  • Pluto 5 years ago

    Speaking of liquidity events, check out how the world’s most liquid market is doing. The Federal Reserve had to inject over $56 billion over just the weekend, to keep money flowing. The BOC doesn’t have that kind of firepower.

    • G B 5 years ago

      Holy Allah. That’s on top of the $104.15 billion the day before.

      To contrast, the BOC only has $120 billion in assets.

      • mtl_matt 5 years ago

        It doesn’t add up, it’s how much overnight liquidity was necessary on a given day.

      • H S 5 years ago

        G B. Stop with the derogatory comment. No need to say Holy Allah.

    • Simon 5 years ago

      “The Bank is the only entity that can fully eliminate banker risk for Canadian-dollar transactions, since it can create Canadian-dollar liquidity as required (and therefore can always meet its Canadian-dollar obligations) and cannot be declared bankrupt or insolvent.” -Bank of Canada Review, Spring 2015

      If the debt is denominated in CAD then the BoC has unlimited firepower. Question is how we want it to use it.

  • Trader Jim 5 years ago

    haha. Did the IMF just steal your correction presentation? Toronto at 57% too high, would need to drop 35% to get to the baseline. If we do your 2% real wage growth, and 2% inflation, we get 28.61% over the next couple of years to correct. I think your model showed probability of a 27% correction needed?

  • Snarky 5 years ago

    I wish mainstream media would highlight this maybe buyers would then come to their senses.
    Correction would follow one people realized the risk. I wonder how long the BOC can supress rates. Crazyy times

  • Simon 5 years ago

    Isn’t the most important variable how much banks are going to lend? Even if a few marginal buyers existed, it’s up to the lender to determine whether they want to follow along with the trend. “The price is what banks say the price is” would be the lesson.

  • Oakville Rob 5 years ago

    Well yes. This is what I have been saying. Not only are today’s prices unsustainable, the idea that prices will increase further is nuts. But they may, and average Canadians will suffer.

    The government could motivate the return foreign owned assets to Canadians by imposing or strengthening vacant house taxes; regulating AirBnB; and curtailing money laundering so it doesn’t corrupt our economy further.

    Then we will have a fire sale of real estate that in turn will mess up anyone who bought a house in the last few years, especially at mortgage renewal time. It’s really a disaster.

    And yet, not one political party seems to be addressing it.

  • SUMSKILLZ 5 years ago

    Coulda, woulda, shoulda….will be said by our bravery free leaders some day.

  • Questionable 5 years ago

    Guess what else happened in 2014-2015 … Severe devaluation of CAD… There’s your answer. If CAD keeps dropping prices will keep growing.

    • Taco Libra 5 years ago

      The “devaluation” is a result of expanded credit print. If you have 10 of something one day, and you divide it into 11 the next, how you think it works?

      To get another bump like 2015, credit would have to hit zero, banks would have to lend for fun, and unemployment needs to go to negatives. 😂

      Over half the population traded homes in the past 10 years. How fast do you think people upgrade?

  • Bill 5 years ago

    The numbers don’t tell the story of how unique Canadian cities are – the level of services, culturual tolerance, diversity, opportunity, safety is far above most cities that are compared with. There are lots of affordable property 1-2 hrs away – yet people ChOOSE to spend what they do to live in downtown Toronto. This type of article has been coming out for over a decade and more will come. Could perhaps consider you aren’t analyzing the whole picture? Lamenting that reality doesn’t follow your data is a very fixed mindset.

    • Canaduh 5 years ago

      Oh yes, our unparalleled uniqueness is known throughout the lands. In fact, when a child is born anywhere but here it is not uncommon to hear the parent’s delicately whisper into their child’s ear, “We’re so sorry this isn’t Canada, land of the chosen ones.”

  • Joe 5 years ago

    If fundamentals and data always prevails in reality, professors would be the richest people around.

    These numbers only paint a side of reality…the ‘what should be’ idea and does not include many other factors. I stress on immigration being a key driver on why prices continue to remain high and we might see even higher peaks. Regular people that work and pay high taxes in this country get the short end of the stick when immigrants coming from countries with much lower taxes bring in their wealth.

    Just one straight forward example, Hong Kong is experiencing a difficult time and if I was a wealthy/better to do middle age person, won’t I try to keep my options open by getting a permanent residence in a country like Canada? If the situation in HK deteriorates, I can simply move my lifetime wealth to Canada and live in a nice house without paying Canadian income taxes throughout my whole life.
    I get free healthcare and all the other benefits that Canada provides (more now with every election! Woohoo!). These people when they move over, become ‘semi-retired’, in the sense that they work for lower income jobs that are less stressful and use their wealth to invest in real estate/equity/etc. Their regular income reported from their jobs here do not reflect what they actually make through other investments which may be tax-free depending on the tax treaty.

    So when data is being gathered for analysis, of course it shows that real estate is overpriced compared to income levels/affordability levels.

    • Bay St Guy 5 years ago

      Incredibly bad take. Professors aren’t market participants.

      The more accurate take is “if fundamentals and data always DON’T prevail, the middle class would be the wealthier than the upper classes.”

      If housing were the way to get rich, 68% of Canadians would be the wealthiest class of people, and we wouldn’t have Canadians on Bay St that earn 7-figure salaries renting. Unless you think 68% of the population is perfect at assessing the proper value for assets, and the one-percent (outside of real estate) has a bad take that primary housing a consumption, not an investment.

  • HBU Consulting 5 years ago

    What is discussed in the comment section is mostly true under the assumption that the prices are driven by local market participants; however, this is clearly not the case, at least for places like Vancouver, Toronto and Montreal.

    So long as no measures to limit/regulate the foreign flow of capital is implemented, you’ll see the trend continues in a fairly sustainable manner. With the exception of a few months in 2008 and 2012, the prices been skyrocketing over the past two decades; has the real income? No. But, given the political stability, safe communities and the clean environment, Canada continues attracting the wealthiest, those who are not bothered by the fundamentals.

    Real estate was never an investment vehicle and a necessity should never become one; however, due to poor policies of many central banks and various governments, it has turned into a solid means of investment and that’s our new reality, like a developing country.

    • Former Canadian 5 years ago

      LOL. Wow. The lunacy of some people is absolutely hilarious.

      If fundamentals detach, how are locals expected to continue to live in these markets? You have nearly 25% of industry based just on buying, selling, and warehousing people. The other 75% of industry is just suppose to constantly raise wages to support the other 25%? At what point do people go, you know what – I’m going to the US, because I can pay for health insurance and STILL come up with a lower cost of living?

      Spoiler, we saw this in the early 1990s, when locals said screw this, I’m moving to the US after the last “immigrants will come here forever” blew Montreal and Toronto into oblivion, only to see prices recover in 2014.

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