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Market Memo: Canada’s world class bubbles

  • First National Financial LP

In its annual review of the world’s biggest real estate bubbles Swiss investment bank, UBS, has placed two Canadian cities in the top five.  Yes, they are Toronto and Vancouver, in that order, at third and fourth place.

Calculating the bubble

The 6ix and YVR have topped such hyper-market stalwarts as London, Paris, New York and San Francisco in the ranking of 20 cities.  All are considered to be financial centres and hubs for their regional economies.  And all have a cost of living that is higher than their surrounding areas.

UBS examines the cities based on local wages, housing prices, mortgage debt, rental markets and other economic fundamentals.  Each city is given a score which places it on a five-point scale that ranges from undervalued to bubble.  A score below -1.5 is undervalued.  A score above +1.5 is a bubble.  Hong Kong, which topped the list, scored +2.03.  Toronto scored +1.95.  Vancouver scored +1.92.

Good news, bad news

There is good news and bad news here.  Last year Toronto was number-one on the bubble list with a score of +2.12.  UBS believes that intervention by all three levels of government have reduced the bubble, dropping the city to third place.  The bank feels rising mortgage rates and the tougher B-20 lending standards will help keep the market stable.  However, the report cautions, a decrease in the value of the Loonie could trigger a return of foreign buyers.

The bad news is that Vancouver’s score is up 12 basis points from last year’s rating of +1.80.  Despite the increase, the city remains in fourth spot.  The report says wage growth and above average rental growth have helped mitigate double-digit price increases over the past four-quarters.  UBS says, with Vancouver’s affordability crunch, increasing mortgage rates could be what it takes to cool Vancouver’s hot market.

For a global comparison, UBS says housing prices in its study cities have increased by about 35% in the past five years.  Vancouver has gone up by double that and Toronto has seen a 50% increase.

In real terms

So what does it mean for people in the market?  Well, money and time are usually very tightly linked.  In order to buy a 675 square-foot apartment in downtown Toronto, a “highly skilled service worker” (someone with a specialized post-secondary education), would have to spend the equivalent of six year’s salary.  In Vancouver that same skilled worker would have to come up with nine year’s salary.

Anyone investing (or speculating) in these markets will also have to take a long-term view.  The bank calculates landlords in Toronto will have to wait 25 years to break even on their rental property.  In Vancouver it will be 34 years.  The report recognizes that many of these investors expect to be rewarded with capital gains as compensation for low rental yields.  But the authors caution that, if those expectations are not met and confidence in the market deteriorates, those high price-to-rental multiples could lead to serious capital losses.  Affordability issues like these can seriously affect a city’s potential for long-term growth.