The increasing cost of house prices in Canada and the financial struggle to purchase a new home has led a few international financial experts to conclude that the housing market in this country is overvalued.
The Economist, Deutsche Bank and Fitch Ratings all weighed in recently about the housing prices in Canada, with all claiming that the market is overvalued by 78%, 60% and 20%, respectively.
The Economist, in January, referred to the Canadian market as the most overvalued in the world, using a price-to-rent ratio of 78% to make that claim. The ratio compares the relationship between the costs of buying versus renting. For good measure, they also employed a price-to-income metric, where Canada's 34% overvaluation was second to France's 35%. That percentage was calculated from house prices versus median income data.
Deutsche Bank reached the same conclusion this past December, placing Canada at the top of a global list. Its report found Canada's price-to-rent ratio was 88% above its historical average, and the price-to-income ratio sat at 32% above its historical average. Using the average of those two figures, Canada's housing market was estimated to be 60% overvalued.
London and New York-based Fitch Ratings used statistics compiled by Canadian banks and other economic data to form a two-step model that assigned home prices a 'sustainable' value and then a 'stressed market' value. In March, Fitch concluded Canadian home prices are overvalued by about 20%.
But it's obvious that overvaluation assessments are not totally objective and relies greatly on what ratios or metrics an economist chooses to use. Diana Petramala, an economist at Toronto Dominion, reiterated in a Globe and Mail post that the price-to-rent ratio pegged by Deutsche Bank is skewed by rent controls, making it difficult to determine whether the prices are too high or if the rents are too low. Additionally, she notes, the price-to-income ratio used by other experts, depends on what they consider as income and if a "more encompassing" definition is chosen, which includes government transfers and investment income, the housing market calculations should differ significantly.
Another point that's essential in any analysis is to factor Toronto and Vancouver as contributors to 40% of the Canadian housing market. It stands to reason that those market figures in particular will drive the overvaluation measure, suggests Petramala in a Toronto Star article.
When looking at the overvaluation calculations, Petramala said that the price-to-rent and price-to-income measures fail to account for the drop in interest rates over the last two decades.
TD's own report released in February used affordability as a preferred index of assessing housing overvaluation. This is the percent of income an average household would have to devote to mortgage payments if they purchased an average priced home and took out a conventional mortgage. Indexes of housing affordability, which are highly sensitive to the level of interest rates, point to a more moderate overvaluation of 10 percent.
The TD assessment aligns with the International Monetary Fund's own research in February 2014, which indicates that the Canadian market is overvalued by about 10%.