(Article and photo courtesy betterdwelling.com)
Canadian real estate prices are the most overvalued in the G7, measured against rents. IMF data shows Canada’s house price-to-rent ratio in Q2 2020 was the highest of any G7 country. The indicator is commonly used by analysts and economists to determine stretched valuations. Home prices across the G7 have grown faster than rents on average. In Canada however, they grew nearly twice as fast as the average, over just a few years.
House Price-To-Rent Ratio
The house price-to-rent (PTR) ratio is the ratio of home prices to annualized rent. It’s often used as a benchmark to figure out if it’s cheaper to rent or own. More important, analysts often use it to figure out if homes are overvalued for a market.
Rental costs are closely tied to wages, with growth limited to what local incomes can support. You can’t easily charge a whole country 20% more rent, if wages are only growing at 2-3%. Home prices however, reflect how much credit the marginal buyer is able to consume. If home prices rise much more than rent, it’s often due to easy credit conditions — not fundamentals.
The IMF uses an indexed approach for tracking the change. They set 2015 as the base year with a value of 100. If the index rises, it means house prices increased faster than rents. If the gap between home prices and rent increases, the index value rises. If the gap between the two closes, the index value falls.
It’s worth stressing once again, the base year of 2015 is set at 100. It gives the impression that 2015 had the correct price ratio, but doesn’t really mean that. Inefficiencies may have started way before that date, and persist to this day. However, we’re going to be mostly talking about how much things have changed since that year.
Canadian Home Prices Grew 28% Faster Than Rent
The Canadian PTR is the highest of any of the G7 countries, with prices rising much faster than rents. Canada comes in at 128.0 for its latest period, which is Q2 2020. This means the gap between home prices and rents grew 28% since 2015. Also worth mentioning, the data is for Q2 2020. Home prices really took off after that quarter, especially in small cities and towns. The disconnect is most likely much larger at this point.
G7 House Price-To-Rent Ratio
US residential real estate is experiencing a similar trend, but not to the extent seen in Canada. US home prices had a PTR of 110.6 for Q2 2020. Home prices saw 10% more growth than rental prices. Canadian home prices accelerated faster than rents, at over twice the rate as the US. Canada is an outlier not just compared to the US, but also compared to other G7 countries.
The Canadian Gap Between Home Prices And Rents Increased The Fastest In The G7
The gap between Canadian home prices and rents, is the fastest growing in the G7. Germany, the second highest PTR ratio in the G7, is 2.1 points lower than Canada. The average G7 PTR ratio is 13.9 points lower than Canada. The Canadian gap grew twice as fast as the average of all G7 countries.
The Canadian home price-to-rent ratio is the most extended of any of the G7 advanced economies. Since the latest data is Q2 2020, this ratio is also likely to have accelerated even further by now. A lot faster, considering prices are now soaring, even in small towns.
Typically a disconnect between home prices and rents is corrected. Any combination of home prices falling, or rents rising would fix it. When the gap is this big though, it’s hard for rent prices to close the gap by much. If it made a big jump in any reasonable amount of time, it would create inflationary pressures for wages. Wages accelerating to handle rising living expenses is an economy’s death sentence.
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