BMO Economics says Canadian home prices are not highly overvalued

Recently a report from the Organization for Economic Co-operation and Development (OECD) claimed that Canadian home prices are 64 per cent overvalued. This has fuelled more debate over Canadian house prices, with much attention focusing on ownership versus renting, and whether or not someone in today’s market should opt to rent instead of buy. In response to this assertion, BMO Economics put out a new report challenging the notion that Canadian home prices are highly overvalued versus the price of renting a home.

“We can confidently dispel the notion that Canadian home prices are egregiously overvalued versus rents, but they’re not cheap either,” said Robert Kavcic, Senior Economist, BMO Capital Markets. “Renting a Toronto condo is a wise alternative to buying for those with a shorter time horizon. However, young families with a longer time horizon in the detached market should not be deterred from buying, but also shouldn’t expect wealth gains like those of the past decade.”

The report noted that on a national basis, ownership currently looks only moderately expensive versus renting. Using current market mortgage rates – around 3 per cent for a five-year fixed rate instead of posted rates – leaves valuations almost bang on their long-run norm.

Kavcic noted that there are regional differences within the numbers: 

•           On the west coast, Vancouver valuations have begun to compress from very elevated levels, though ownership still remains expensive versus renting;

•           In Calgary, both housing prices and rent prices are rising, so the gap is stable. Calgary’s market looks pricey, but well below levels seen at the height of the energy boom, and resurgent rent growth has helped offset recent price gains;

•           Toronto appears only slightly overvalued compared to historical norms, but not at all at prevailing 3 per cent mortgage rates. Notably, the city is miles away from the severe bubble conditions seen in the late 1980s.

When considering the question of renting versus buying, BMO Economics looked at two scenarios in the Toronto market: a condo with a five-year horizon, and a detached home with a 15-year horizon.

The Short Term

“With a raft of completions potentially hitting the resale market in the coming years and interest rates expected to grind higher, Toronto condos will have to defy some stiff headwinds,” noted Kavcic.  “While we would downplay the bubble talk, the risk of buying for a five-year period probably outweighs the potential reward given current market conditions.”

The Long Run

For detached houses with a 15-year horizon, current valuations don’t appear to be a major deterrent to buying for the long run. “The practical limitations of moving a family among – or even finding – detached properties, associated moving costs every few years, and the likelihood of not actually selling after 15 years – given significant closing costs and mortgage payments stopping after 25 years – all add to the case for buying,” said Kavcic.

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