| Global Real Estate Ratios Show Extent Of Bubble |
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November 13th, 2008 www.tradersnarrative.co Real estate, as an asset, derives its value from two sources: personal income and rents. The first makes it possible for an owner occupied property to be purchased while the second allows for an investor to purchase real estate. The following charts show the relationship between real estate prices and these two variables: ![]() real estate price to income ratio oecd data ![]() real estate price to rent ratio oecd data
The data is normalized with 100 being the long term average. Here are some quick take aways:
You can check out the OECD report yourself to get the full details. There are many more countries included but I didn’t show them because the charts would have gotten too busy. In any case, they were either too small as an economy or the data was at neither extreme so it wasn’t interesting. Look in the free resource section for the full spreadsheet. |
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Comments
The annualized ratio is comparable to the P/E of a stock (for which 8.08 is considered quite good!).
The only real problem with this approach is that you can’t really look up ratios for different areas easily. For example, what’s the average Price-Rent Ratio for Toronto? I have no idea! I’d love to know if Kingston or Waterloo have a better Price-Rent Ratio, but that’s not something I can easily look-up, unfortunately.
If you COULD determine this Canada-wide, a community with a very low Price-Rent Ratio, a decent population size and a low vacancy rate (say under 5%) would be an EXCELLENT place to purchase / build rental properties (the other info can be easily determined).
People sometimes talk about properties being cash-flow property from day 1 with 0% down, and I can’t imagine that very many deals like this are possible! As I’m writing this, I did some calculations. Given the fact that my property is $250 cash-flow positive. At the interest rate I’m paying (5.05%), the property could afforded an additional $250 / month in interest, which means I could have afforded to borrow another $59,405.94 (250*12/5.05%). Since I’ve put less than this into the property, if I could somehow have gotten the interest rate I got with 0% down (say with a VTB or something), I could have had this property cash-flow positive with nothing down, so I guess it IS possible.
Neat.
And comparing real estate price to rent, to stock price to EBITDA isn't appropriate either unless the nature of the underlying assets is similar.
People in general tend to massively under-estimate the effect of future taxes on their property, and the cost of maintenance, when they do their calculations.
Price-to-Rent Ratio = Real Estate Price / Annual Rent
The price-to-rent ratio can indicate whether home prices are rising or falling or the desirability of owning rather than renting. The average ratio for 1987-2007 has been about 15 (source: Home Prices Seem Far From Bottom), meaning that home prices were 15 times the annual rent that could be earned from the homes. During the real estate bubble 2005 - 2007, the price-to-rent ratio increased to more than 20 times in some areas.
Example—Calcula ting the Price-to-Rent Ratio
If a residential home cost $200,000 and rents for $1,000 per month, what is its price-to-rent ratio?
Annual Rent = $1,000 x 12 = $12,000
Price-to-Rent Ratio = $200,000 / $12,000 = 16.67
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