Friday, January 25, 2013

The Biggest Real Estate Bubble in the World is in....

Canada have the biggest housing bubble in the world right now according to The Economist.

Like other financial assets, there should be a fair relationship between the price of housing and the stream of income (rent) it produces. The chart below, from The Economist, looks at the price-to-rent ratios across different countries, and measures how under-or-overvalued housing is, with negative numbers corresponding to the former and positive ones to the latter.

Source: The Economist

To gauge whether homes are cheap or expensive we use two measures, both of which compare current estimates with a long-run average (in most countries, going back to 1975). This average is our benchmark for “fair value”.

The first gauge is a price-to-rents ratio. This is analogous to the price-earnings ratio used for equities, with the rents going to property investors (or saved by homeowners) equivalent to corporate profits. The measure displays a massive range, from a whopping 78% overvaluation in Canada to an undervaluation of 37% in Japan. The other measure, the ratio of prices to disposable income per person, stretches from a 35% overvaluation in France to a 36% undervaluation, again in Japan.

Overvaluation is especially marked in Canada, particularly with respect to rents (78%) but also in relation to income (34%). Mark Carney, the country’s central-bank governor, who is soon to jump ship to join the Bank of England, where he takes over from Sir Mervyn King in July, may have shown good market timing with his move to London as well as a deft hand in negotiating his lavish remuneration. Singapore and Hong Kong also look vulnerable to a correction, given the overvaluation on their price-to-rents ratios.

See the full story in the Economist here.

Geir Solem

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