Fellow blogger Ben Jones consistently argues in his The Housing Bubble blog that a real estate bubble in housing prices can be found not only in the United States but also in many countries around the world. I’ve made earlier posts about the bubble and what I intend to do about it?
I wanted to take another look at this issue after a lunch-time chat with a co-worker. She maintained that home prices only increase, which is not true according to MLS data. In fact, real (inflation-adjusted) home prices in Toronto are still below their last peak in 1989.
It is undeniable that home prices have been on a tear recently. In Ottawa, for example, after remaining virtually flat for much of the nineties, home prices have recently trended as follows: 2.4% (1999), 6.6% (2000), 10.3% (2001), 14.1% (2002), 9.0% (2003), 7.8% (2004). Over a 15-year period (1990-2004), raw home prices in Ottawa have increased about 66%. Healthy? Yes. Bubble? Probably not.
Another way to look at home prices is to compare the price of an average home with median household income. In Ottawa, the average home is priced at $235,678 and the median household income was $62,130 in 2000 (last census data available). So, it takes roughly 3.5 years of median household income to buy an average home. Again, home prices seem reasonable by this measure.
What about affordability? It is clear that home prices have risen sharply due to historically low interest rates. Royal Bank publishes detailed research on housing affordability (% of pre-tax household income devoted to home ownership including mortgage payments, taxes and utilities), which reveals that affordability at 34.2% is still at historical lows across Canada. In Ottawa, carrying costs at 30.6% are also close to historical lows.
Some economists use P/E ratio to determine if housing prices are in a bubble. Using data from Royal LePage, a detached bungalow in parts of Ottawa costs about $221,000, pays about $3,100 in taxes and rents for about $1,700, which yields about 7.8%. Not bad, when you compare it to 5 year fixed mortgages at 4.8%. In 2000, a similar bungalow yielded 9.8% when interest rates were close to 7%.
While it is possible that pockets of housing bubbles might exist, my analysis shows that most home prices in Ottawa (which is a typical market in Canada) are not in any bubble.
