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Toronto's Housing Bubble is just Bad Metrics

There has been a lot of talk recently about Toronto’s housing bubble. In fact, I think if you check, the talk has been filling up the press for several years. Well if all of these people are right about the bubble, when is it going to pop? I don’t think in fact that there is much of a bubble, I just think it is bad metrics. (I can feel you getting all excited out there…”oh, goody”, you’re saying, “we get to talk about metrics.” Calm down there, let’s not get too excited.)

Let’s look first at the common metric used to declare there is a housing bubble. That metric shows the relationship between the average house price and the average income earned. You can see that ratio demonstrated on the lovely graph I created showing data for the city of Toronto.

Going back to 1976, the graph shows the average house price in blue and the ratio between house prices and income in the red line. It looks just terrible doesn’t it? This is the metric that everyone is using to show a bubble.

Unfortunately in the land of metrics, comparing house prices to income is just silly. What matters isn’t the price of the house but what you pay on mortgage to own the house. So there is another factor which is left out of the bubble analysis and that is interest rates. I’ll explain how that all works in tomorrow’s post.

Meanwhile, I saw an article on the weekend with even sillier analysis. BMO has done some extensive research (I think they actually just played with Excel one day) and come up with the claim that even Toronto’s 1% are being priced out of the housing market. You can see the article summarized in Huffington Post.

The research says that someone earning $225,000 (the 1% cutoff line) can’t afford the average house. The analysis says that with $100,000 down, the most that a 1%er could afford would be $987,000 but the average detached house is $1.2 million.

This is just crazy though. Since when do people who make $225,000 a year only have $100,000 for a down payment? Don’t you think that people earning $225,000 a year might have had a house for some time now. After all, I don’t know many people for whom $225,000 is a starting salary.

And if they have been earning $225,000 and had a house for a while, let’s say 10 years, don’t you think they would have a big chunk of equity in their house? In fact if they bought the average house 10 years ago with $100,000 down, their house cost $350,000 and after paying a mortgage for 10 years, they would have $537,000 of equity

On this basis they could, according to BMO’s statistics, afford a house worth $1.45 million, well above the $1.2 million average.

I know you’re finding this to be exciting stuff so tomorrow I’ll show you a better metric to use when evaluating the housing market and you’ll see why the bubble everyone claims might not be quite as alarmingly large as everyone thinks.