Financial blogger looks even deeper into Canada’s real estate market and doesn’t like what he sees

Financial blogger looks even deeper into Canada’s real estate market and doesn’t like what he sees

It’s expensive to buy property here (Image: Katrin Shumakov)

The sense of foreboding that’s lurking around Toronto’s real estate market can be distilled down to one relatively simple phenomenon: a lot of observers are concerned that prices have moved way out of equilibrium and that there’s an unavoidable correction on the horizon (economist speak for a big drop in home prices). That sense of foreboding became even more acute earlier this week with news that Toronto is the second most expensive city for homeowners in Canada (as always, Torontonians nervous about their home investments can take comfort in the fact that Vancouver is even more out of whack).

Earlier this summer, The Economic Analyst, a blog by college professor and financial adviser Ben Rabidoux, offered a particularly compelling—and chilling—explanation for what’s in store for the housing market:

None of this is particularly new. In fact, in a 2005 paper, the OECD recognized the massive, anomalous rise in price and rent ratio across Canada. With the exception of a brief dip in 2008 and 2009, we know that prices have far exceeded rental growth since 2005. What does this imply for future price movements?

…when the price to rent ratio is too far out of whack, the bulk of the movement to realign the ratio occurs via a change in house prices rather than a change in rent.  In other words, when the price/rent ratio is at historic highs, as it is in Canada, it is likely that the realignment will come by falling or stagnant house prices rather than rapidly rising rents.

Basically, for much of the last 30 years Canadian cities have had a predictable balance between property values and rent. But that means that to rectify the current imbalance, either rents have to rise or prices have to drop. The problem is that if Rabidoux is correct, the latter is much more likely than the former—which means Toronto homeowners are right to be feeling a wee bit wary.

Examining house prices and rents in major Canadian cities [The Economy Analyst]