I was going through my emails and found this question from a prospect in December 2014. I answered with a view that I still believe exists to some extent in the residential Canadian Real Estate market today (not the overall market as some indicators have changed). Without further due, I invite you to read the exchange. That being said, I am still interested to hear your views. hope you enjoy it!
Poloz said that Canadian homes might be overpriced by 30% but then again, Bank of Canada predicts only modest gains in the future (and not an actual 30% dip in values). What is that supposed to mean? What determines value, other than demand and affordability? Is there some other equation he is using to calculate the value of real estate? And what are people supposed to do with that information?
"The Bank of Canada said Canadian house prices have been overvalued by least 10 per cent since 2007 and may now have overshot by anywhere from 10 to 30 percent, relative to incomes and interest rates source: Globe & Mail Hint: relative to incomes and interest rates.
The BOC is examining the house prices by solely considering the two above noted indicators. Let's look at income for a minute, in simple terms, they don't see an increase in house prices in the household incomes (the motive behind the increasing low affordability in Toronto and some of the other jurisdictions). The ordinary person's income is not growing as fast as the value of the homes - absolute truth. Also, the comparison made is based on the reported incomes and doesn't take into consideration the non-reporting and the under-reporting that take place. Considering the affordability, one could easily make a statement that prices are 10-30% higher than what they will be. In the current stage of our Real Estate market, the demand outweighs the affordability. Hence, the high demand is what determines the value, not affordability.
I do agree with homes being overvalued as a result of what I noted above, however, I don't agree with such figures as, I find it a bit too rich. What drives the market is a high level of demand that has emerged by foreign investments, they see Canadian RE market as a safe heaven and have long-term hold strategies. Such factors mixed with record low-interest rate leads to increased demand.
In my opinion, if there would be any correction in the housing market, it would be in the high-rise/condo sector and it would be a moderate one (simply due to oversupply of units). If that ever happens, the low vacancy rate in the rental market for such asset class could off-set the risk till the cycle is passed. I don't see that happening with lower density residential housing as there has been shortage since 1986 and a restriction such as "Green Belt" wouldn't help mitigate the situation.
Now in terms of the Interest rate, nothing drastic will happen. Pressure on bond pricing may lead to a bit of increase in the Fixed rate mortgages but the Prime will most likely stay the same (prime rate always moves up/down by quarter point). Our economy is not as rosy overall taking into account all sectors and their indicators (and not solely RE). Hence, I don't predict any sudden changes considering the level that our core inflation is at.
To answer your question about what people do with this information, I certainly believe BOC is just trying to bring some sense to those that are overheating the RE market by overbidding. I just see such an announcement as "a word of caution" targeting those type of buyers. Real estate could also be valued by income VS cost approach but that is in the Micro level and not Macro.