There is no shortage of great blogs posts on the Canadian residential real estate market. Garth Turner is an excellent writer who has been the canary in the coal mine for quite some time now. Ben Rabidoux also has stated how the real estate market is overvalued. Saj Karsen and Hardcore Value mention it as well. Yours truly even took a stab at it.
After reading Demographia international housing, I needed to see for myself. It seemed like Edmonton wasn’t as overpriced as I had once thought. For the record, I don’t remember who gave me the report.
I have compiled some data in regards to Edmonton specifically. I wanted to see where we are if I looked at the Edmonton market historically. Just like equities I needed some sort of valuation measurements to see “fair value” and make any necessary decisions.
Full disclosure, I bought my house in 2004. It wasn’t a function of what I thought the real estate market would do, it just made sense at the time relative to renting. It is a really small 50+ year old house. Being as debt adverse as I am, I put 25% down and made it my goal to pay it off by the time I am 30. Since then I have rethought that approach and have focused on paying off the mortgage and saving for my retirement through the purchase of public companies in tax sheltered accounts.
Here is a price chart for average residential real estate price since 1962. I pulled the data from this site.
This doesn’t say too much other than prices go up over a long time. The chart below shows inflation adjusted prices. I grabbed the CPI numbers from the government of Canada website. The numbers in the 60s are for Canada as a whole, after that I have Alberta specific numbers.
You can see a wicked run unlike anything seen in the last 50 years starting in 2005. I also put in a price channel to show what happens in oil country when we have an oil boom. You can see that during the last oil boom we had a big run in prices as well. The most recent run has eclipsed the last. In order to get back to the top of the channel prices have to fall 24%. To get to the bottom its 42%. If you look closely you can see that in real terms if you bought at the previous high, it took you 20 years to make a profit from price appreciation.
Here I took the data and added in a range of 30% above and below the average price. Why 30%? I needed a wide enough variance to account for cyclical peaks and troughs. 30% seemed like a decent number. The inflation adjusted price spends 68% of its time within the 30% +/- range, so it seems like a decent valuation measurement.
In order to get to the top of the range prices have to fall 24%. To get to average they have to fall 40%. To get to the bottom they have to fall almost 60%.
So by measure of historical value we are at best overvalued by 25%.
Moving to price to personal income. I feel the best measurement would have been price to household income after debt service costs. I used personal income from the government of Canada. The numbers were calculated a little different over the periods so I have to blend some together which is likely leading to a distortion.
Pretty much the same story as before. You can see the big run of the last 5-7 years followed by a period of stability. I also added at 30% range like before.
It’s interesting to note that at the previous peak in the late 70s early 80s, the price/income stopped at the 30% range. It is only now that prices have made a new channel, although likely temporarily. This time we spend 80% within the range.
To get to the top of the channel prices need to drop 7%. To get to average prices need to drop 27%. To get to the bottom of the channel prices need to drop 45%.
I like this measurement best, but it can be distorted. Things like more income earners per house over the last 50 years could play a factor. More importantly is the cost of borrowing.
Last go around we had falling interest rates to act as a cushion. Top that off with record personal debt levels in Canada means there is a strong chance of mean reversion.
Here are some quotes from people that I have asked about the residential real estate market in Canada.
“Can’t go wrong owning property. I don’t know why you waste your time on stocks when you can just buy property and forget about it.”
-Real estate “investor” who owns 4 rental properties
“You should absolutely consider your home as part of your net worth. Even if you never plan to sell it or earn income from it.”
-Financial Planner at the local bank
“Sure prices have moved quite a bit in the last 10 years, but that doesn’t mean that they will fall.”
-Real estate agent advertising in the community newsletter
“We’ll see who’s smarter in 10 years… me or you.”
What does it all mean?
Expect some sort of mean reversion in the Canadian housing market. Vancouver and Toronto are the most exposed, while this phenomenon is almost nationwide. The CMHC is encouraging this behaviour which it kind of scary and upsetting at the same time.
The only thing that has me doubting myself on this one is the fact that so many people are sounding the alarm bells on this. Maybe it’s just the internet allowing us to connect in ways that we never have before.
I won’t try to time it, but I have made some steps to minimize the impact. I will write another post to share what I think is best for me and my family.