North American Economics

Writing about the San Diego housing market, Rich Toscano at Piggington’s Econo-Almanac has a great explanation of the historical relationships between house prices, incomes and rents.

Longtime readers know that I consider the price ratios to be absolutely fundamental to determining whether housing is fairly valued. It makes intuitive sense that home prices would tend to track incomes and rents: incomes, because they determine how much money people have available to pay for housing; and rents, because rent prices reflect how much San Diegans are willing and able to pay to put roofs over their heads when there is no speculative or investment element involved. The historical record bears out this intuitive logic, as San Diego’s home price-to-income and price-to-rent ratios have tended to be strongly mean-reverting over time.

He includes the following two graphs showing how San Diego’s ratios are now back to normal levels after the bursting of the housing bubble.


Here are the ratios for Vancouver:

The San Diego ratios were calculated with slightly different data, so the absolute numbers aren’t the same as Vancouver’s. However, today’s deviation from historical averages in Vancouver are comparable with the situation in San Diego in 2005.

So what is the likely future for home prices in Vancouver? Unless Vancouver is different, historical price-to-rent and price-to-income ratios will return at some point. Absent a significant jump in incomes and rents, the only way these ratios can get back to normal levels is with a very significant drop in prices. If this was to occur over the next couple of years, it would take a 40-50% fall. Like this: