Mish Mailbag: How Does One Tell If Houses Are Overpriced?

Tonight I received a question from a "Concerned Canadian" about home prices.

However, my answer does not change regardless of where someone lives. The same metrics apply universally.

"CC" asks:

Hello Mish,

Recently, I watched a video clip in which you mentioned to Max Keiser that there is a huge real estate bubble in Canada. I am Canadian and that comment caught me off guard.

I would like to do a bit of due diligence. Can you point me to an article or two that I could read, or can tell me the key points that convinced you that there is 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?

Thanks,

Concerned Canadian

Here is the video in question: Mish Videos - On the Edge with Max Keiser.

Dear CC

You do not need articles. You just need common sense.

Here are some things you should consider.

#1) How much are home price out of whack with rental prices? (i.e. What does it cost to own vs. 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 vs. 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 are not unlimited. The desirability of San Diego and Miami did not stop a crash in the US. It will not stop a crash in Vancouver either. Moreover, desirability can change at a moment's notice as happened in Florida and Las Vegas.

Your 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 are better off renting. The more out of line they are, the better off renting you are, anywhere 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 is 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 are not 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 (you cannot just walk away), you need to be all the more cautious.

Use common sense, not emotion. Don't get trapped.

Mike "Mish" Shedlock
http://globaleconomicanalysis.blogspot.com
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