House prices: Examining inflation and supply/demand factors

I continue to work with some CREA data to find historic relationships between house prices and other factors.  I posted earlier on the historic correlation between house prices and per capita GDP, which shows significant overvaluation on a nation wide basis.  Today we’ll look quickly at inflation and then at some supply and demand factors.

As a reminder, this is dealing with aggregate Canadian data.  This is not to suggest that house prices everywhere are significantly overvalued.  Certainly there are a handful of particularly bubbly locales, but it is increasingly evident that even the more ‘reasonably’ priced areas are at the top of their long-term historic norms when measured against underlying fundamentals.

House prices and inflation

It was bubble guru and Yale economist Robert Shiller who famously calculated that house prices in the US have done little more than pace inflation over the past century.

In fact, the most extensive historic housing data set in the entire world verifies this finding.  Price data for the Herengracht Canal in Amsterdam extends all the way back to the early 1600s.  Remarkably, real (inflation-adjusted) house prices have moved around a long-term trend line over the past 350 years.  That is to say that houses essentially pace inflation over time. Source:  Piet Eichholtz as cited by Steve Keen

Note that periods of under performance relative to inflation were eventually corrected with rapid moves to the upside, while periods of over performance relative to inflation resulted in an eventual correction to the down side.  Note however that this can happen via a reduction in house prices or a stagnation in house prices while inflation catches up (the ‘soft landing’ thesis, if you will).

Here in Canada, inflation is often measured using the Consumer Price Index which tracks changes in a basket of consumer goods.  If house prices typically track broad measures of inflation over a long enough time horizon, how have we fared here in Canada?

Cumulative house price gains have far exceeded the cumulative growth in the CPI over the past 30 years.  Now it should be acknowledged that the starting point makes a great deal of difference in this case as it could be argued that we may have started from a period of significant house price undervaluation which would imply that the growth in housing relative to inflation is merely “catching up”.  This is a valid point, though the massive divergence between the two trends certainly argues against the notion that house prices are simply catching up.

Of note, many have criticized the CPI for understating inflation.  As John noted when we discussed the New House Price Index (NHPI), it is this index that is used as the input into the CPI measure, arguably understating true inflation.  I went ahead and plotted the same data series but this time I assumed that CPI had understated inflation by 50%.  There is no rationale for choosing 50% as an adjustment other than to simply illustrate how significantly government stats would have to be adjusted over each of the past 30 years in order to compensate for the massive divergence.  Here is the result:

It would essentially mean that house prices would have lagged inflation over much of the previous 30 years before rapidly rocketing past the inflation trend line in the past 5 years.

House prices and population growth

I want to now take a moment and discuss two often-cited arguments to support house prices at current levels:

1)  Immigration and population growth will continue to drive prices.

2)  Canada has not experienced the level of overbuilding experienced by the US.

Let’s start with the first statement.  While immigration and population growth can lead to higher property prices, they do so only under the relatively rare instances that the housing industry either cannot build houses fast enough to meet the demand or that current land restrictions prohibit building in highly desirable locations.  This second point is the primary focus of Demographia, the organization that releases the annual affordability rankings of international housing markets.

Aside from those two isolated instances, population growth in and of itself should have very little impact on aggregate house prices.  Nevertheless, let’s see data:

Here we see cumulative house price increase since 1980 plotted against increases in total population and growth in immigration.

If we broke down the annual change in house prices and plotted them against the annual change in total population and immigration as a percent of total population in each year, we see the following:

Note that in each case the correlational coefficient is negative, strangely enough, though both are insignificant.  In essence, these findings seem to mirror the findings of Steve Keen who found that immigration and population change had little impact on house prices in and of themselves.

No overbuilding?

One of the most commonly used arguments in support of the stability of our housing market relative to our southern neighbours is the supposed lack of overbuilding in Canada.  It is alleged that rampant speculation and overbuilding led to the supply glut that we currently see south of the border.

To validate this statement, I plotted the annual rate of housing starts per 10,000 people in both Canada and the US all the way back to 1980.  I found population data from Stats Canada and the World Bank, and housing starts data from CMHC and the National Association of Home Builders (NAHB).  Here are the results:

As you can see from the data, the US hasn’t built more homes than Canada on a per capita basis since 2001.  Over the entire 30 year period, housing starts per 10,000 averaged  61 in Canada and only 54 in the US.

It appears from this data that the “massive overbuilding” argument is highly suspect.

More to follow…



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37 Responses to House prices: Examining inflation and supply/demand factors

  1. Liam from Calgary says:

    Canada is not the US. Get over it

    • SuperPL says:

      It is not, your geography is spot on my friend. Calgary is also still 10% below its peak prices. Id hate to be out 50,000$ and still singing that tune.

  2. John in Ottawa says:

    Lots of stuff here; it is going to take some time to go over it.

  3. Sams Mango says:

    Great work Ben – and a good place to start. The best comment I heard from a friend in Toronto the other day, “for a million and half bucks is where i can get something decent, where my friends won’t laugh at me”

    Outside of that, my renters are still paying away with no issues. People would rather rent a “cool” place then own a place and be laughed at. I am able to demand higher rents also for larger flats with nice kitchen and bath. Feels ok to be a landlord.

    That is my 2 cents from the ground.
    New condo’s are still being populated from “just out school/my first job in the city/parents making down payments” types.

    Don’t see anything getting me worried about market breaking.

    • Joe Q. says:

      Your friend must have high standards. $1.5M buys you two average detached homes in Toronto. Prices are high here, but this ain’t Vancouver.

  4. Joe Q. says:

    I’m never sure where the idea of “lots of immigrants” supporting home prices comes from. We had lots of immigrants in the late 1980s and early 1990s, but prices still crashed. One look at your graph illustrates this quite nicely.

    • BBC says:

      Totally agree. The only reason why the ‘asian money’ gets any ‘air time’ is that they seem to be the last standing every time….similar to the 80’s!

  5. Mark says:

    Thanks for answering the overbuilding question! I had been wondering about that one for a long time and had not found an answer anywhere until now. I was actually quite surprised because I was expecting overbuilding to have been much higher in the States relative to Canada. You’re doing a great job digging up the data and presenting it very well. This blog is starting to remind me of Rich Toscano’s original blog about the RE bubble in San Diego ( – the blog is still active) – I lived there during the bubble years from 1999 until 2006. Rich suspected how things would turn out but always had lots of data to back up his opinions. It seems you are running a similar shop here. Thanks for all your hard work crunching the numbers and looking at all the angles. This quality of analysis just does not exist in the mainstream media.

  6. jesse says:

    If one believes CPI is understated, there is a multi-trillion dollar bond market that disagrees.

    • jwg says:

      Why? Because people do not seek out some amount of relatively safe investments even if these may pay less than inflation? Bernanke is trying to keep a low interest rate, with huge increase in gov’t debt, to spur entrepreneurial investment. Not much sign it’s working.

  7. Declan says:

    I like the chart on construction rates, that’s a good way to present the data.

    Ideally, you’d look at population growth rather than total population (we don’t need new houses for the existing people), but population growth rates have been almost identical in Canada and the U.S. for quite some time, so you can get away with just plotting against the population size.

  8. Michael says:

    It would have been nice if you had attributed the Herengracht index to Piet Eichholtz, who created it and drew the original of the graph you reproduced, which appeared in Real Estate Economics 1997, Vol 25, p. 175-192.
    Steve Keen may be a great economist but I am sure he would not want to take the credit.

  9. John in Ottawa says:

    I finally got a chance to give this post a careful reading. Ben, that was a lot of effort.

    Again, though, I worry about aggregation, both in Canada and in the US. The US run up and crash in house prices was far from evenly distributed. States like Ohio and Kansas, even Texas, barely noticed either side of the curve. Canadian markets such as Windor, Ontario, or Moncton, NB will likely experience the same non-event.

    The vast bulk of the over building occurred in the sun belt states of California, Arizona, Nevada and Florida. They also suffered the worst crashes. Still, overbuilding was likely a coincident factor.

    Regarding inflation, the CPI is such a massaged number I don’t know what to think of it. Between hedonic adjustments and substitution, plus the removal of food and fuel, it is hard to know where we stand with inflation. Add in the change in taxes (of all kinds) between 1960 and today, about another 10-15% of disposable income is gone. This is all to suggest that house prices certainly appear to have outpaced the ability to pay and still have some kind of life beyond the mortgage. I have also long been suspicious that price inflation is greater in the west than in the east.

    On the other hand, low interest rates have mitigated the affordability problem nation wide (for the time being).

    In looking at immigration, once again we need to avoid aggregates. Alberta and Saskatchewan have had significantly more immigration than Ontario or Quebec. In particular, they have had the benefit of emigration from Ontario and Quebec. So we cannot look at Canada’s net immigration and population growth in isolation. We have to look at net immigration within each particular market. Anyone remember Calgary Mayor Ralph Klien’s “Bums and Scum” reference from the early 80s?

    As I have said many times, Canada is simply too large, its population too small, and its economy too regional to make national aggregates of any kind very useful. National aggregates hide more than they illuminate. Even in the US, if you look at the Case-Shiller numbers for price reductions in the 20 cities, they range from -7.3% in Dallas to -57% in Las Vegas. From a big yawn to an unmitigated disaster. Prices in North Dakota, of all inhospitable places, have gone up.

    Vancouver and Calgary may already be giving us an idea of what a correction may look like. So far, they are experiencing a moderate roll back with an undulating stagnation. Perhaps that can continue for a significant period.

    If the US is to provide us with any lesson, it is that even a crash affects various economic strata differently. The lower income, lower priced houses ran up faster and farther in the US and crashed harder and further than the upper income, upper priced houses in percentage terms. In hindsight, that eventuality is somewhat intuitive.

    I continue to believe that corrections are going to be regional (or local) and may be spaced in time based on local economic factors. This would not be unprecedented in Canada. Of course, a significant correction in a single market such as Vancouver or Toronto will show up as a significant correction in the national aggregate price simply because all other markets are so small in comparison.

    • Sams Mango says:

      The only thing that makes them national is our banks. They turn off the taps, the whole sucker goes down


      Great madani work in wall street journal today about cad home bubble. Needs a password I think

      • John in Ottawa says:

        Yes, if credit disappeared it would be all over. That’s what happened in the US.

        What would cause Canadian banks to withdraw credit? The Canadian government would have to declare an end to CMHC and that would be political suicide. Might as well declare an end to national health care and the CPP while they are at it.

      • SuperPL says:

        Exactly, without cheap credit (with long amorts) actual earning will dictate prices.

        According to latest stats 75% of tax filling Canadians make 50,000 or less.

        In the long run disposable income always dictates prices.

    • Hi John

      I’ll see what I can find with regards to more regional data. You are absolutely correct that aggregate data is far from perfect. I certainly don’t disputes this. Absent the more useful regional data, I still believe that this data is useful in raising some warning bells and highlighting some potential problems in our future.

      • John in Ottawa says:

        Ben, I agree with you that working with national data at least gives us some clues to the future. The difficulty in obtaining regional data remains a huge frustration.

  10. Josh L says:

    A lot of good work here and graphs. One thing that strikes me about the Herengracht Canal graph. It clearly shows the market is subject to wild swings, but it also seems to show that the market can remain irrationally high and irrationally low for periods exceeding 50 years (with a few minor peaks and valleys along the way). It would also seem to me that there was a great deal of war and turmoil during the major low throughout the 1800’s. So while I agree that our market is irrationally high, who’s to say we’re not in a stage similar to the early 1700’s where the market remained historically high for close to 20 years and even after a breif “crash” (back to the average) remained higher than average for another 30 years before finally plunging (presumably due to a war or a historic swing in interest or other historical event)?

    I’m not personally going to tempt fate in this regard, but your critics could be right for close to 50 years even just because markets can remain irrational much longer than they should (especially when the government has a reason to keep them that way). Just playing devil’s advocate.

    • Sams Mango says:

      This guy has been wrong his whole career. He couldn’t get a market call right with insider information

    • jesse says:

      Rosenberg is looking at the wrong indicators for valuations. Wage inflation needs to increase significantly or there is impending distress for balance sheets on the horizon.

      It’s an interesting point, though. Immigration of late seems to be of a different flavour: in-migrants are arriving in greater numbers with better wealth positions than the incumbents. That’s a massive shift in demographic makeup, away from the old “foreign PhDs start at the bottom” model of generations past.

      • Sams Mango says:

        very true observation. The second generation of that PhD cabbie didn’t do so well, if the PhD cabbie had stayed put and not come to Canada, his off-spring would have been better off and is now coming to Canada on own merit

  11. jesse says:

    CalculatedRisk has a post on price-rent in the US:

    “An interesting point: the measure of Owners’ Equivalent Rent (OER) is at about the same level as two years – so the price-to-rent ratio has mostly followed changes in nominal house prices since then. Rents are starting to increase again, and OER will probably increase in 2011 – lowering the price-to-rent ratio.”

    OER is likely going up in the US. You heard him.

  12. Sams Mango says:

    I believe the FP write up on income provides the data that makes the case for “outside money, savings and cash earnings” even stronger to help explain the Cad house price mystery. Over the last 15 years, after the last housing crash, people have saved and avoided housing in the high rate environment. Now with low rates and ramped up savings, we see the push higher in prices. This probably gives a great insight on the next leg, which again seems to be starting from a low leverage base and becomes stale to toppy, but not any sort crash in a US fashion.

  13. Sams Mango says:

    also, wanted to add a few points

    – Low LTV embedded in CMHC
    – no CANHOU bond pool is mostly made up 5/40
    – Canadians have paid down debt well
    – no tax incentives to keep outstanding debt
    – Booming job market
    – High density of educated you folks

    Not making the argument for a bullish case, but rather a continued slow growth upward in prices.

    • Certainly some of those points are valid, but I’d disagree with a couple of them, particularly the notion that Canadians have paid down debt well and that we have a booming job market (outside of construction and the public sector…and part time jobs in general).

    • SuperPL says:

      Ontario is suffering and bleeding jobs, regardless of what job creation stat say. Well paying jobs are declining by the minute and are replaced by low paying jobs.

      • Sams Mango says:

        Where are they going? Be clear with some examples.

      • SuperPL says:

        China, India, Eastern Europe to name a few. These are the “bread and butter” manufacturing jobs Ontario was built on. There is very little IT jobs left as well (from what I encounter). Most good IT jobs were replaced by entry level low paying local support while majority is outsourced to India.
        Only thing really propping Ontario up was construction and public sector but I thin this is coming to an end (even if the rest of Canada keeps on ticking). Ontario Libs essentially ran the province into the ground financially. I strongly believe that the next Ontario government will severely cut infrastructure spending and start cutting public sector jobs, pushing Ontario unemployment rate easily into double digits.

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  16. Michael says:

    Very interesting points Ben.
    Could you elaborate on what to look for when an asset bubble is near the breaking point?

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