Three Ways to Know if Houses Are Overpriced
The same metrics apply universally.
Tonight I received a question from a "Concerned Canadian" about home prices.
However, my answer doesn't change regardless of where someone lives. The same metrics apply universally.
"Recently, I watched a video clip in which you mentioned to Max Keiser that there's a huge real estate bubble in Canada. I am Canadian and that comment caught me off guard.
"I'd like to do a bit of due diligence. Can you point me to an article or two that I could read, or can you tell me the key points that convinced you that there's a real estate bubble in Canada?
"If there is a bubble and the bubble bursts, are residential real estate prices likely to decline in Canada as they did in the USA? Would one be better off renting rather than owning a home?"
Here is the video in question: Mish Videos -- On the Edge with Max Keiser.
With regards to the answer to the question, articles aren't really necessary. Here are some things you should consider.
1. How much are home prices out of whack with rental prices? (i.e., What does it cost to own versus rent a similar house? Keep in mind maintenance, property taxes, etc.)
2. How much above the trendline growth in price appreciation are home prices selling? (Was there an unexpected or unwarranted acceleration in prices over a number of years?)
3. How much have home prices appreciated versus wages?
Any of those significantly above their trendline is a huge warning sign. When bubbles burst, prices will not only revert to the mean,but overshoot as well.
Note that housing markets will vary based on availability of jobs, local wages, and amenities. Thus, cities like Vancouver and Toronto will carry premiums just as San Diego, Chicago, and New York do. However, premiums aren't unlimited. The desirability of San Diego and Miami didn't stop a crash in the US and it won't stop a crash in Vancouver, either. Moreover, desirability can change at a moment's notice as happened in Florida and Las Vegas.
The question is not really about Canada, given the same metrics apply to London England, Sydney Australia, Shanghai China, or anywhere else. Simply put: The more out of line those factors are, the bigger the bubble. And the bigger the bubble, the bigger the crash.
There may be other considerations, but financially speaking, if home prices are out of line with rental prices, wages and wage growth, and jobs, you're better off renting. That's true worldwide.
Regardless of rental prices, don't be a debt slave to your house and don't buy just because home prices are going up!
At times it may seem that greater fools are everywhere. However, that's the way things always look at market tops. Here's three things to always keep in mind:
1. The pool of greater fools is not endless.
2. Unlike stocks, houses aren't liquid.
3. Sentiment can change on a dime, far faster than someone can sell a house. That applies double for condos.
Finally, if mortgages in Canada are recourse loans (meaning you can't just walk away), you need to be all the more cautious.
Use common sense, not emotion. Don't get trapped.
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