Blessed by the Potato

There are at least a half dozen measures that you can use to tell whether the real estate market is over- or under-valued.

Some are purely historic, relative to a long-term trend line (such as looking at inflation-adjusted returns vs. a long-term trend of about 0.5-1% above inflation — a 5-year run of ~5-10%/yr probably signals trouble). Those can be handy, especially for looking across different sectors and for trying to point out to people that something has gone awry, but may not take into account actual “it’s different this time factors” that can kink the trendline such as the construction of a subway line, the changing of the laws (such as relaxing downpayment requirements), or large demographic shifts (post-war; Toronto vs Montreal).

Some reference a general affordability of housing; here I find the simpler ones are better. Looking at median income and median housing prices, and looking to see what the multiple is works a lot better than the formulas that try to measure affordability as a combination of interest rates, taxes, etc., because these formulas can be “tricked” by interest rates that are out of whack with historical norms (i.e.: if interest rates are very low, and housing prices high, you could get a moderate level of affordability when in reality things are getting out of hand). Worse yet are cases where your formula is constructed wrong, as happened with the UBC study that accidentally(??) included housing appreciation in its measure of affordability.

Personally, I prefer the measures of comparing rentals vs purchases. For the simple reason that it’s a measure that is easy to determine on your own (no need to run to Statistics Canada or a secret realtor cabal to get your data, just see how many times the monthly rent goes into the purchase price of the unit you want to live in), and it’s the most relevant to my personal situation of trying to figure out how I should live my life. After all, you’ve got to live somewhere, and you may have an idea of where that somewhere is. If there is indeed a premium to living in Toronto or Vancouver vs London or Seattle, and that’s where your job is and you want to live, then you’re just gonna have to pay that premium. Saying it’s not in-line with historical trends is not going to change the way things are for putting a roof over your head today. However, you still have to make the decision between renting a place or owning it (and surprisingly often, both options can be available for the same unit). If the rent multiplier is 200X then forgetaboutit, dilemma solved, you rent. If it’s 100X then hey, pick up two places and rent the other out, because you may have just found yourself an investment worth owning, or at the very least, you’ve found a city where it’s cheaper to own your shelter than rent it.

There are of course more factors to the rent-vs-buy argument, and you can calculate it out in detail if you like, but this is a nice, simple, round number that’s easy to use, and easy to talk about.