Housing prices fundamentals depend a great deal on the wider economy, especially income and borrowing rates. More specifically, housing prices bear chiefly fret over two important measures: 1) the ratio of house prices to median income and 2) the ratio of rental income to house prices.
House prices to median income now equals 3.8 pretty much in both the United States and Canada, which means that the median price of an interest in land is now getting out of reach of the average North-American household. This measure is the primary catalyst to what economists refer to as ‘The Affordability Crisis', and is becoming more and more a concern. The Affordability Crisis is a very serious matter indeed. It has economic, political, social and demographic reverberations and repercussions.
The hot local real estate markets of recent times have driven prices literally through the roof and since home-ownership is the single most important element in the democratization of prosperity, un-affordability becomes a social problem just as much as an economic one. It impacts the very essence of North American wealth reserves and distribution, because home-ownership is the element of social stability and cohesion and, therefore, an important pillar of a sustainable modern economic capitalistic growth.
The second measure, the ratio of rental income to house prices is too low to offer property owners and investors a decent return, suggesting again that houses are badly overpriced. At 0.5 percent, rental income over house prices indicates that investors will think twice before purchasing rental properties, since they have investment alternatives. For instance, here in Downtown Vancouver it used to be, only a couple of years ago, that purchasing an apartment unit and then rent it out would net a yearly return of over 8 percent. But since rental rates have not followed at par with real capital appreciation, taking into account increased property tax the yield is nowadays less than 5 percent.
Nearly everyone now expects prices to level off for a bit and slow the economy down, but in ultimate analysis the foregoing valuation measures are less worrisome than one might think at first.
The high ratio of house prices to income is less alarming because low mortgage rates in both the United States and Canada have held down the real, effective cost of owning a home. This cost has not changed much despite an upward shift in interest rates, which in turn has increased volatility in real estate markets. North-American homeowners, especially in the United States, remain exposed to a sharp rise in long-term interest rates if, say, foreign investors in the American Treasury were to start selling bonds and put their money elsewhere. But this does not seem to be the case for the time being, as confidence in American financial stability is at an all-time high.
Furthermore, although it is true that rents have failed to keep pace with the rising prices of interests in land, that comparison partly reflects a failure to adjust for the growing quality of the homes Americans and Canadians have been buying. This, coupled by the fact that demand for rents is now beginning to move up, would suggest that rising rents could raise the threshold and set the ratio on a more balanced footing - so long as incomes keep growing.
An additional reason for optimism is that prices of real estate in Britain and Australia, two other countries that bubble-watchers have been fingering as examples of the impending and devastating real estate bubbles in North America, have proven much less damaging than many expected. Their respective economies have performed so well after real estate markets peaked, that their central banks found it necessary to raise interest rates again afterwards.
For all the foregoing reasons many economic forecaster and analysts here do not believe that a recession is around the corner merely because of the slowdown in real estate. And I am one of them.
Luigi Frascati
Luigi Frascati is a Real Estate Agent based in Vancouver, British Columbia. He holds a Bachelor Degree in Economics and maintains a weblog entitled the Real Estate Chronicle at http://wwwrealestatechronicle.blogspot.com where you can find the full collection of his articles on Real Estate Economics and Finance. Luigi is associated with the Sutton Group, the largest real estate organization in Canada, and is based with Sutton-Centre Realty in Burnaby, BC.
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