The Canadian Housing Market in Layman's Terms - Part 2 - The Valuation Question
"A quick glance and common sense should tell you if the numbers will work. The rest are details." - Derek Sivers, Anything You Want
Home ownership for many is not just an investment, but a measure of success, which is why the Canadian housing market is much discussed: it's an emotional issue. It's hard to go by a single week without reading some sort of commentary on it.
It all begs the question whether the housing market is overvalued or not.
The Wikipedia article on economic bubbles has an interesting section at the bottom about identifying asset bubbles, where it lists the characteristics of a bubble.
The very first one listed is "unusual changes in single measures, or relationships among measures (e.g., ratios) relative to their historical levels."
It goes on to list several more, but this first one is significant because it comprises well-defined metrics/relationships that can be compared over time and across different markets.
The Affordability Index is the one of the most frequently touted metric, usually defined by ownership costs as a percentage of median income. All it tells you is the percentage of your income required to own the roof over your head. If over time the ownership costs rise faster than your income (Affordability Index goes up), having a house gets relatively more expensive.
Another measure is the price-to-rent ratio, which is defined as the ratio of home prices to annual rental rates. It is simply a tool for gauging whether it would be better to rent or buy a house. If over time house prices rise faster than rents, owning a house gets relatively more expensive than renting.
The OECD website has this amazing chart that shows exactly that: just how much higher some of these metrics are trending relative to their historical levels. This chart was produced in 2014, and these metrics have only trended higher since then (as can be seen in this great article and chart).
