Real estate affordability ratio is flawed

Not all things are created equal

nolan The Latin phrase Ceteris peribus, or “all else being equal,” is used extensively in economics to  guide relatively simple predictions – the price of a candy bar, for example.

Yet it’s a virtually useless tool in predicting the path of an economy. All else is very rarely ever equal.

Hillard MacBeth’s recent crystal-ball-smashing predictions the Canadian housing market will crash by as much as 50 per cent appears to hold several things equal, when in fact they are far from the same. In fact, his assessment of affordability is not only flawed, but essentially useless, and seems to be more sales pitch than forecast.

In a recent interview with Canadian Real Estate Wealth, MacBeth sourced data looking at only one or two aspects of the housing market, namely oil prices and the ratio of house prices to income. While the ratio of house prices to income is an interesting number, it is an inaccurate measure of affordability. Why? Because it looks at two pieces of data that may be related, but are not equivalent.

MacBeth should not be looking at housing prices in relation to income. He should have compared the cost of owning a home in relation to income, which is a far better indicator of affordability.

The ratio of housing prices to income assumes interest rates are constant. Yet as everyone at this point knows, interest rates have not been constant for a long time. And low interest rates increase affordability.

The RBC Report on Affordability supports the claim that Calgary, and most of Canada, is more affordable than what MacBeth’s price-to-income ratio indicates. It assesses affordability not based on the price of the home, but on the monthly carrying costs such as the mortgage payment and utilities in relationship to incomes.

Calgary’s market, as it turns out, is one of the most affordable in the country, favouring the more affordable side of its long-term range, not the less affordable as MacBeth would have you believe. In fact, Calgarians spend just under 40 per cent of their respective incomes on homes, according to RBC’s assessment – one of the lowest among major urban centres in Canada.

Unfortunately, many financial planners have felt the pain recently of Canadian investors flocking to both online investment platforms and real estate. One can’t help but wonder if predictions such as MacBeth’s have more to do with driving money back toward alternate investments than in providing unbiased commentary on the real estate market.

Unbiased financial advice is hard to find these days. Mutual fund salespeople only want to sell mutual funds, stock brokers stocks, life insurance agents life insurance. It is hard to find someone who will just give you the straight goods.

That’s why Mortgage360 started Cash Flow Club, and why a balanced portfolio of not only real estate, but other asset classes as well is a major component of its seminars. The next Cash Flow Club meeting is April 2. Register at mortgage360.ca/cash-flow.

Nolan Matthias holds a degree in Economics, is an Accredited Mortgage Professional, and the author of The Mortgaged Millionaire. Mortgage360 was founded by Nolan & Jen Matthias in 2010, and established itself as a standalone brokerage in November 2014.

Leave a Reply

Your email address will not be published. Required fields are marked *