Affordability Measures Point to 'Overvalued' Western Canada Markets

Written by Posted On Wednesday, 17 October 2007 17:00

For many years, RBC economics, a division of Canada's largest chartered bank, has been tracking housing affordability in quarterly reports. The most recent report in September showed that the portion of before-tax household income that goes toward home ownership costs "suffered one of its largest and most broadly based quarterly deteriorations in the current housing cycle stretching back to the mid-1990s."

"Affordability deteriorated in every housing class we track, in every province and in every city," says the report by Derek Holt and Amy Goldbloom at RBC Economics. "Housing market conditions from Manitoba eastward are not a cause for concern, but conditions in Saskatchewan, Alberta and British Colombia warrant caution, given the speed of the massive turnaround in affordability in several key cities," says the report. "In our view, a continued cooling in the pace of price gains and an ongoing pull back in sales-to-listings ratios lie in the cards for these cities."

Goldbloom also conducted a further analysis of housing markets that went beyond the standard RBC affordability study. She says that while the affordability measure tracks trends in wages, capital costs, energy prices and taxes, it has limitations. It doesn't track whether house prices are high by historical standards and how they compare to the local rental market, and it doesn't account for recent financial innovations such as long-amortization mortgages that are relatively new to the Canadian market.

Goldbloom says that when the affordability measure is analyzed along with the price-to-rent ratio, they can assess whether housing markets are inflated. The price-to-rent ratio is similar to the price-to-dividend ratio in the stock market, she says, and compares the cost of buying compared to the cost of renting a house.

"From 2002 to 2007, major markets across the country saw average annual price growth of 11 per cent with a sizeable degree of regional variation around this average," says the report. "Western cities were significantly above the average, while much of central and eastern Canada came in well below the national average."

She notes that "a rapid run-up in house prices is not necessarily a sign of an overvalued market" because real estate is priced locally and differs across the country.

Goldbloom says that Victoria and Vancouver "have the highest price-to-rent ratios in the country. These markets are widely regarded as the most expensive real estate markets in the country, with average prices roughly 45 per cent above the national average … . These dynamics have fed through into significant erosion to affordability conditions right across British Columbia." However, she says the market in B.C. is gradually moving back into more balanced supply and demand conditions.

Calgary is averaging annual house price growth of 23 per cent this year (down from 40 per cent last year) and Edmonton is averaging annual growth of 45 per cent. "With house prices sharply outpacing both rent and incomes for three consecutive years, there is now substantial evidence of an overvalued market" in the Alberta cities, says the report. "Fundamentals are still supportive of an overall healthy market going forward, particularly with oil breaking new highs, but the steep acceleration in the ratio is signaling a market ripe for moderation in the coming years. Markets in Alberta have already started to show some signs of more moderate activity compared to its blockbuster year of 2006."

Saskatoon, Saskatchewan, has seen soaring house prices and price-to-rent ratios in the last year. "The sudden and steep acceleration in price-to-rent ratios coincides with the sharpest deterioration in affordability on record," says the Goldbloom. "More expensive conditions already appear to be pricing people out of the market. Fifty per cent price gains are starting to weigh on demand and softer demand should feed through to cooler price gains ahead."

In contrast to the Wild West, the Central Canada markets in Toronto and Ottawa are considered healthy and stable. Price gains are in the four to five per cent range, and "conditions are not out of whack with the underlying fundamentals," says Goldbloom. "After the bursting of the housing bubble in the late 1980s, these markets went through a decade-long adjustment period and actually saw declining price-to-rent ratios until about 1996 when they bottomed out," she says. "The trend has since reversed as the cost of home ownership compared to renting gradually increased as markets recovered from a significant correction."

In Quebec, income growth has been healthy and Goldbloom says the housing market does not appear to be out of line with the underlying financial fundamentals. Atlantic Canada has also seen price-to-rent ratios pushed higher, and the market has been showing signs of moderating demand. "Markets are in the midst of a re-balancing act and do not appear overvalued relative to fundamentals," says Goldbloom.

She concludes that while there is definite evidence that the western markets are overvalued, "markets from Manitoba eastward appear, on balance, to be fairly valued."

Rate this item
(0 votes)
Jim Adair

Jim Adair has been writing about Canadian real estate, home building and renovation issues for more than 40 years. He is the former editor of Canada’s leading trade magazine for real estate professionals, as well as several home building, décor and renovation titles. You can contact him at [email protected]

Realty Times

From buying and selling advice for consumers to money-making tips for Agents, our content, updated daily, has made Realty Times® a must-read, and see, for anyone involved in Real Estate.