From Motley Fool:
Investor Marty Whitman once
said that “Rarely do more than three or four variables really count. Everything
else is noise.”
One variable that “really
counts” in real estate is home prices in relation to average incomes. People
have to pay for their homes over time, and that money has to come from income.
While the short run is dominated by changes in interest rates and supply, there
is little historical precedent for home prices growing faster than incomes over
time.
Measure average home prices
against average incomes, and you get this:
During America’s bubble, we
made all kinds of excuses for home prices growing faster than incomes. We said
housing was special. We said mortgage rates would stay low. We said we
could always sell our home to someone else. And we were wrong about all three.
By 2010 the price-to-income ratio of American homes plunged back to historic
average levels, where the humble laws of financial arithmetic said they
belonged.
Another useful metric is home
prices measured against average rents. It shows more of the same:
Americans once tried to justify
home prices rising faster than rents. We said there was pride in owning a home.
We said renting was throwing your money away. We said owning a home provided
freedom. But we ignored that rents are to homes what earnings are to stocks — a
symbol of valuation that, over time, act as an anchor on prices. The price-to-rent
ratio in Canada has risen by 70% since 2000. One Canadian commenter told a
personal story atThe Daily Beast recently: “Buyers in Toronto are
paying $1,958 a month to buy a place they could rent for $1,104.” That is
neither sustainable nor rational over time.
The thing to realize about the price-to-rent ratio is that it is not effected by immigration. Any new demand due to the growing population puts equal pressure on both rents and home prices. Some even argue that immigration puts even more pressure on rents than on housing prices as newcomers usually rent before buying. Yet, even with increased pressure on rents from the newcomers to Canada, the price-to-rent ratio still keeps rising.