Jan 052015
 
The Bank of Canada Governor Stephen Poloz stated last month that this country’s housing market could be overvalued by as much as 30%. This may very well be true, but it’s nothing to be alarmed about. 😉 In fact I would be really surprised if our real estate market was not overpriced given what’s going on in the rest of the economy. Toronto’s real estate has increased almost every single year for the last 19 years, except in 2009.
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A large part for the seemingly illogical run-up in real estate prices in Canada, the U.S., England, Australia, and parts of Asia over the last 2 decades, can be rationally explained by TINA, which is an acronym for There is No Alternative, a term first made popular by Margaret Thatcher. It’s the same reason North American stock markets reached all time highs at the end of 2014. 🙂 The Canadian Stock market is currently overpriced by more than 20% according to historical averages. The S&P 500 stock market index in the United States currently has a P/E ratio of 20. That’s 25% more overvalued than the historical average P/E ratio of around 16.

There has to be more sellers than buyers for prices to drop. But many home owners view their properties as investments. And if they sell their homes today they won’t have a viable alternative for all that cash. Both stocks and bonds are overvalued too. By comparing a 20 year real estate chart like the one above, to a 20 year stock market chart it’s easy to understand why most Canadians would rather own real estate, even though it’s overvalued by 10% to 30%, than own a basket of volatile stocks that can fall 50% in value during a recession.
This is why real estate prices are so high. There just isn’t anything else that’s more attractive for investors out there. The investment options outside of Canada don’t hold a lot of promise either. The labor force participation rate in the U.S. is at a low which hasn’t been seen since 1978. Europe is still fighting disinflation. Brazil’s GDP has hit a brick wall. India is trying to contain its inflation. China’s growth rate has been slowing for years. And there are all sorts of political and economic problems going on in Russia right now, including an oil revenue crisis.
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So with no good alternatives, home owners who don’t have to sell their properties will continue to hold onto them. Meanwhile first time home buyers are entering the market all the time. Since demand is stronger than supply, it’s only natural for the price of real estate to move higher. Overvalued doesn’t mean imminent correction if everything else is overvalued too because all markets are relative. 🙂
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Random Useless Fact:
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Guest

Great post Liquid. I like how you show that nearly every asset class is overvalued to some degree by historical standards. I think we are seeing the effect of cheap money and it will be interesting to see how things unfold when interest rates rise.

Vivianne
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It wouldn’t surprise me, as I’ve been outbid on 5 houses. People were paying $10-20k over the asking price. Some people in the hot real estate area were saying that were outbid by $100-200K, just 10% of asking price, but when we talking about about $1.xx million dollars houses, these figures are huge. Cheap money keep coming, pretty soon, there will be correction and deflation, another wave of defaulting. Oyyy… I hope interest rate will rise sooner than later.

Karen
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When you say my house cost me $575000, it does still sound quite expensive. However, when you say it cost over half a million dollars, it really emphasizes just how overpriced the real estate market is. A lot of people can’t afford a house in Toronto, so they then look at houses in the neighbouring cities. But then even those houses are pretty expensive. When my fiance and I were looking at houses, some semi-detached houses were selling for $400-$500K! Pretty soon almost all the land will be developed and overpriced.

No offence but I saw the preview for Ascending Jupiter and I thought it looked stupid. Lol. However, the Avengers movie looks awesome!

Anonymous
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Anonymous

‘There is no alternative’ sounds an awful lot like, ‘It’s different this time.’ Let’s hope you are right on this for your sake. Like many Canadians, you are betting a lot on a single asset class.

http://business.financialpost.com/2015/01/08/deutsche-bank-reveals-7-reasons-why-canada-is-in-serious-trouble-starting-with-a-63-overvalued-housing-market/

Vivianne
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Even if you betting money on “a single asset class”, it doesn’t seem that way, the way Liquid does it stuff though. Says, he bought his loft for $300K. In reality in he only invest $60K. He only puts in 20%. It is lucrative and attractive, because stocks can appreciate 3-10% a year. And housing can appreciate 5%/yr (he can get $15K/yr). That is a 25% return on investment. It is one of though you do it you damn, you don’t do it you are still damn. 😛 because continuing to rent is not the solution, wasting money on rent and not able to deduct it from taxes if you lives in States. Not an easy problem to solve, the world only have a fix spaces to build, eventually, your land will have to worth more, inflation will eat it up if you only keep cash.

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[…] I’ve been itching to invest the new $1,700 in my TFSA. But the problem was TINA. The stock market in general is grossly overvalued relative to historical price to earning ratios. […]

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[…] In the past we’ve seen stock market bubbles pop, real estate bubbles pop, and yes, even farmland prices have sharply corrected before. Right now in 2015 it’s a fascinating time because it feels like almost everything is in a bubble. […]