The Economist vs. BMO Nesbitt Burns: is Toronto real estate overpriced or ridiculously overpriced?

Apparently, nobody is willing to argue with a straight face that Toronto real estate is a bargain. That’s the lesson we learned while reading up on the debate between The Economist and Canadian investment bank BMO Nesbitt Burns. A few weeks ago, the British economy mag put out an article saying that Canada’s real estate market was overpriced by almost 24 per cent, compared to the U.S., where the terminal real estate market is underpriced by 2.1 per cent. Of course, this might give people the idea that it was time to stop buying and start selling, so BMO Nesbitt Burns has today released a study telling those Limeys to brush up on their figures.

In our view, comparing house prices with personal income, rather than rent, provides a superior methodology… the historical trend for this ratio has a zero slope, meaning prices tend to rise alongside incomes over time. This makes sense, since a family’s income largely determines how much it can pay for a house…

Comparing the current ratio with the long-term trend suggests Canadian house prices hit a peak overvaluation of 18% in late 2009. This raises some concern because it suggests the market is only slightly less overpriced than in the late 1980s, or compared with the U.S. in 2006. However, a 3% decline in (seasonally-adjusted) prices so far this year, coupled with continued moderate income growth, has reduced the estimated degree of overvaluation to a less worrisome 11% in 2010Q3.

Hooray! Canadian real estate isn’t overvalued by 23.9 per cent; it’s overvalued by 11 per cent!

BMO Nesbitt Burns says most of that overvaluation is in Vancouver, so presumably Toronto’s real estate is just a teensy bit overvalued. It’s pretty explicit in its release that Ontario is not seeing a repeat of the 1980s real estate boom, with overvaluation only half as bad as 25 years ago. They say that Canada’s real estate market is not in a bubble at all, and certainly not heading toward a U.S.-style collapse.

If anyone is still inclined to worry about this, here’s a discordant note: Dean Baker was one of the earliest and loudest voices warning about flaws in the U.S. real estate market, and he seems to think that relying on home price–to–personal income ratios is bunk.

This is why people hate economists. Ask two economists a question, and wait for three answers.

• Canadian Housing: Pricey, Not Dicey [BMO Nesbitt Burns—PDF]
• Canada’s housing market ‘pricey, not dicey,’ BMO says [Globe and Mail]
• Floor to ceiling [Economist]