Real Estate Prices Are High Because Canadians Want To Pay More, Says BMO Economist | Better Dwelling

Real Estate Prices Are High Because Canadians Want To Pay More, Says BMO Economist | Better Dwelling

One of Canada’s Big Six banks thinks it cracked the real estate price situation. BMO’s chief economist, Douglas Porter, wrote a recent analysis on the gap between Canadian and US home prices. As recently as 2017, he maintained many markets were in a bubble. However, he’s come to embrace the lack of affordability. The noted economist, concluded Canadians just pay more because they want to. He doesn’t believe it’s a misalignment of resources typical of a bubble either. Instead, he questions those that judge people who pay more, because it’s their preference. Uh… okay, let’s unpack this report.

Comparing Home Prices Using Purchasing Power Parity (PPP)

BMO used the purchasing power parity (PPP) exchange in their calculations. PPP is a comparison of the purchasing power of a currency, not just its exchange rate. To determine this, they compare what a “basket of goods” would cost in both currencies. Using PPP is popular with economists, because it helps adjust for local incomes. According to BMO, it’s been fairly consistent, and is currently an 0.83 ratio.

Canadian Home Prices Are 46% Higher Than In The US

Using this method, there’s a massive gap between Canadian and US home prices. In December, the seasonally adjusted average Canadian home was CA$617,000. In the US, this was just over US$350,000, or CA$420,000 after adjusting for PPP. The gap works out to Canadians paying 46% more than Americans, on average.

Just to confirm the absurdity, BMO’s chief economist decides to compare both by exchange rate anyway. Using Friday’s exchange rate, the average US home price is about $445,000. That still works out to over 40% higher. That’s with the Canadian dollar having advanced quite a bit since last year. 

Most Reasons Commonly Attributed To The Gap Are Just Noise

Why the discrepancy? Well, the economist dives through common issues used to explain the gap. Lower interest rates in Canada? That’s offset by longer US amortizations. Canada’s urban concentration? That’s where incomes are stretched the most. He doesn’t mention Canada’s rural properties are more expensive than some US cities. However, that’s something we’ll dive into on another day. There is a ton more though.

Homeownership rates? US homeownership rates have recovered since the Great Recession. They’re now similar to Canada’s last reported levels. Tax treatment? Canada’s capital gains exemption is likely offset by US mortgage interest deduction. Population is the only argument with any real validity, due to immigration. He does believe this will be corrected with the new US government’s immigration reform. If none of those are the primary reason, what’s the deal?

BMO Thinks Canadians Just Enjoy Spending More

Porter thinks Canadian home prices are expensive because Canadians want them to be. The economist states Canadians may “…have made a collective choice to allocate more resources to housing than other countries.” He doesn’t however think that’s a “misalignment of resources,” as would be typical in a bubble. He further adds, “while some dismiss it as “consumption”, who is to judge if this type of consumption is better or worse than other forms of spending?”

In other words, a “Big Six” bank thinks spending more on real estate is just a national pastime. It not being a misallocation of resources, is an odd take though. If Canadians are spending 10 points more to service their mortgage, that’s money diverted from other aspects of consumption. By diverting this money from industries with higher GDP velocity, this puts a drag on GDP growth. Something that was falling on a per capita basis before the pandemic, many just didn’t notice.

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This content was originally published here.

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