Vancouver, Toronto Among the Most Overvalued Housing Markets in the World

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After years of rising property prices in Canada’s two hottest markets, Vancouver and Toronto are now considered to be two of the most overvalued markets in the world.

Swiss bank UBS recently released its Global Real Estate Bubble Index which placed Toronto as the second most overvalued market in the world after Munich while Vancouver came in sixth place.

The report traces the fundamental valuation of housing markets, the valuation of cities in relation to their country and economic distortions that capture lending and building booms. Ultimately, the index score is a weighted average of the five key variables, namely, price-to-income, price-to-rent, changes in mortgage-to-gross domestic product and in construction-to-GDP ratios, and relative price-city-to-country indicator. Based on these factors, UBS designates those cities with an index factor of 1.5 or greater to be considered a “bubble risk."

It shouldn’t be any surprise that at some point Vancouver and Toronto both fall in the top 10 of overvalued markets. In fact, Toronto saw its real housing prices in the city almost triple between 2000 and 2017. Similar price increases were present in Vancouver, however with housing affordability overstretched, it was only a matter of time before the market started to correct itself. Just in the past year alone, prices have declined by 8.7%. But with the benchmark price of a detached home at $1,406,200 in September, there is definitely room for further price corrections.

At the national level, home prices increased by 5% per annum between 2000 and 2018 in the Canadian cities included in the UBS analysis. Although impressive, growth in other cities was not aggressive enough to justify any bubble risk.

The cool down in Vancouver can be largely attributed to the introduction of a foreign buyer’s tax, an empty home tax and newly introduced rent controls. Furthermore, lower mortgage rates have also encouraged home buyers to enter the market due to fear of missing out.

To give a more in-depth perspective, the number of years a skilled service worker needs to work to be able to buy a 650-square-foot apartment near downtown Vancouver has now increased from five years in 2009 to eight years today. In comparison, Toronto increased from three years in 2009 to six years today. These may sound high, but comparing this to Hong Kong, the average citizen would need to work 21 years to buy that same apartment near the city centre.

When looking at the number of years an apartment needs to be rented out to pay back the cost of the apartment, Vancouver residents now need to wait 29 years to recover their initial investment compared to only 20 years back in 2009. Toronto fares much better, but also saw a nine year jump from 16 years in 2009 to 25 years today. Again, these figures are much lower than the 37 years of rental income it would take to cover the cost of the acquisition in Zurich.

The UBS report also highlights that some markets are fairly valued with an index ranging from negative 0.5 to 0.5. Major markets in this category include Singapore, Boston and Milan. Chicago was the only undervalued market that was listed on the report with an index rate of negative 0.77. These markets may be best for investors looking to hold assets for longer terms so that they can reap the benefits of these fairly priced properties.

Looking at Chicago for example, it would only require a skilled worker to work for three years to purchase a 650-square-foot apartment near the city centre while it would require 12 years for an owner to rent out the unit to recoup his or her investment. Theoretically, these housing assets would be a better return on investment in the long run.

For the time being, demand for housing in Toronto and Vancouver remain strong. The realities of income levels and strict housing regulations, though, are starting to trickle down into the market, ultimately contributing to the realignment of prices. This may take some time, but investors should be hesitant as indications from rent growth and purchase prices have been on the decline in Vancouver and potentially could soon follow in Toronto. For those long-term investors, it may be time to start looking at diversifying portfolios outside of real estate or at least into real estate markets that are undervalued.