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|Mario Lefebvre |
Centre for Municipal Studies
A recent study by the Organisation for Economic Cooperation and Development (OECD) suggests that house prices in Canada are overvalued by as much as 30 per cent! This result is obtained by comparing the ratio of current average house prices to disposable income per capita to its historical average. The Canadian market would be even more over-valued, according to the OECD study, if one compares the ratio of house prices to rent to its historical average. Indeed, according to this measure, the Canadian housing market would be a whopping 64 per cent over-valued.
This is scary stuff and definitely a headline grabber. But I say, hang on just one minute. When looking into these numbers a bit more closely, there is no need to panic.
Let’s first consider the other countries that the OECD flags as having over-valued housing markets. In total, 27 countries are included in the study and eight of them are over-valued by at least 20 per cent according to both measures described above. In order, starting with the most over-valued, these eight countries are:
- New Zealand
- United Kingdom
Interestingly, all eight countries have some of the highest proportion of foreign-born populations in the world. Even more striking, three of the eight most over-valued housing markets are located in the countries with the largest shares of foreign-born population: Australia, New Zealand and Canada.
But why does the share of the foreign-born population belong in this discussion? Well, as it turns out, the foreign-born population can significantly alter the landscape of a country’s housing market. In many instances, immigrants arrive in a new country with some pre-established wealth. If a specific market welcomes a relatively large share of wealthy immigrants, their arrival creates a new source of demand that not only stimulates demand for housing, but can also raise house prices significantly without any changes to personal disposable income per capita. Accordingly, a rising share of the foreign-born population can lead to a higher house price-to-disposable income per capita ratio. Therefore, comparing the current ratio to its historical value to determine whether a country is over-valued might be a little too simplistic.
Let’s consider some numbers for Canada. Overall, Canada’s average existing home prices grew by 5.2 per cent per year between 1981 and 2012. Meanwhile, personal disposable income per capita grew by 3.9 per cent per year, for a spread of roughly 1.3 percentage points per year. Now let’s consider the country’s census metropolitan areas (CMAs) with the largest shares of the foreign-born population: Toronto, with a share of 46 per cent in 2011, and Vancouver, at 40 per cent in 2011. In these two markets, the average existing house price grew respectively by 6.2 per cent per year and by 6.4 per cent per year over the 1981 to 2012 time frame. All the while, average annual personal disposable income growth barely reached 3.5 per cent in both Toronto and Vancouver. Therefore, for both Vancouver and Toronto, the gap between house price inflation and growth in personal disposable income per capita was more than double the national average.
Of course, Toronto and Vancouver’s somewhat lagging personal disposable income per capita performance cannot be put entirely on a higher share of foreign-born population. This is particularly true over the past decade or so, when notable increases in personal disposable income per capita took place in Alberta and Saskatchewan, as both provinces reap the substantial benefits of a boom in the energy sector. All the while, Ontario, and thus Toronto, was dealing with the struggles of the manufacturing sector while British Columbia’s forestry sector was feeling the pinch of a very soft housing market in the United States.
Notwithstanding the developments of the past 10-plus years, data still show that for the past 30 years, markets with a higher share of foreign-born population have been associated with smaller increases in personal disposable income per capita. This finding is not all that surprising for two reasons:
- more labour supply from the large influx of people in a given market tends to have a depressing impact on compensation increases; and
the data show that wages for foreign-born population tend to be lower than a country’s average wage.
Together, these forces suggest that a market with a higher share of foreign-born population should post generally smaller overall wage increases.
From the analysis above, it appears that markets with higher shares of foreign-born population are associated with higher ratio of average house prices-to-average disposable income per capita, at least for Canada. And since the share of the foreign-born population has been rising continuously in Canada, from 16 per cent in 1981 to 20.6 per cent in 2011, one should therefore expect a steady rise in the house price-to-disposable income per capita ratio. Concluding that Canada’s housing market is over-valued by 30 per cent by simply comparing its current ratio of average house price-to-disposable income per capita to its historical average is thus inappropriate since this ratio tends to increase over time.
In the end, while the Conference Board of Canada does expect modest house price increases in the near future, and even some slight declines in some markets, we stick to our positioning that Canada’s housing market is nowhere near about to correct drastically, as the OECD study seems to suggest.