So begins the Economist’s landmark article on the global RE bubble from June 2005. It’s now available for free viewing after years behind the pay wall.
This is the classic analysis of the housing bubble IMHO and the one that made me bearish on RE. Its arguments are my arguments.
“The most compelling evidence that home prices are over-valued in many countries is the diverging relationship between house prices and rents. The ratio of prices to rents is a sort of price/earnings ratio for the housing market. Just as the price of a share should equal the discounted present value of future dividends, so the price of a house should reflect the future benefits of ownership, either as rental income for an investor or the rent saved by an owner-occupier.”
And there you have it. It’s possible to ascertain whether housing is over-valued because it’s an investment, whether or not its owners think of it as one, or what they mean by an “investment” in the first place. Eventually market forces and marginal pricing must prevail and that means that prices must fall back to a level justified by rental value.
Do read the article if you haven’t already, and try adding Vancouver (or other major Canadian markets, or just the Canadian average) to the graphs. How do we look compared to the US and other countries in 2005?