I've seen far too many people claiming that it's safe to buy a house in Hamilton, Ontario the last month. This goes to show how distorted the average view of real estate prices has become. Sure, relative to Toronto's $645,000 average, prices look "reasonable" in Hamilton at $305,000. But, turns out, that's not the issue. Every market has its own mean it will revert to. Every market has a local wage base households can draw on to afford housing.
We have been living through an unprecedented period of cheap and free flowing credit. This has set "affordability" measures off kilter and driven up prices. This credit situation has gone on a long time, but it is temporary. When it changes, prices will begin to revert to their mean. Just because you can't lose as much in Hamilton as you would in Toronto, doesn't mean you won't get burned.
Here is a chart of the price index from housepriceindex.ca along with the inflation adjusted index number starting from 2000, using the Bank of Canada inflation calculator.
You'll notice that the last time prices rose the same as inflation was 2000-2001. That gives us our base price. The mean price that future prices will try to revert to. The actual index (blue line) and inflation adjusted index (red line) have been plotted together to show how badly real prices have diverged from the sustainable line. You'll notice the graph is even zero based on the Y axis and still see how much diversion there is.
So what's the risk? In 2000 the average price of a freehold was $160,000, give or take a rounding error. As of last month the price is now $305,000. If we hop on over to the BoC's handy inflation calculator and look up what 160k is worth today, it comes up with $207,000. That's where prices should be. Turns out they are just about $100,000 above that. Or, about 50% overvalued and needing a 33% decline to bring things back to normal.
But, hey, what's a $100,000 loss?
We have been living through an unprecedented period of cheap and free flowing credit. This has set "affordability" measures off kilter and driven up prices. This credit situation has gone on a long time, but it is temporary. When it changes, prices will begin to revert to their mean. Just because you can't lose as much in Hamilton as you would in Toronto, doesn't mean you won't get burned.
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| Hamilton Ontario Historical House Prices Inflation 2000-2012 |
You'll notice that the last time prices rose the same as inflation was 2000-2001. That gives us our base price. The mean price that future prices will try to revert to. The actual index (blue line) and inflation adjusted index (red line) have been plotted together to show how badly real prices have diverged from the sustainable line. You'll notice the graph is even zero based on the Y axis and still see how much diversion there is.
So what's the risk? In 2000 the average price of a freehold was $160,000, give or take a rounding error. As of last month the price is now $305,000. If we hop on over to the BoC's handy inflation calculator and look up what 160k is worth today, it comes up with $207,000. That's where prices should be. Turns out they are just about $100,000 above that. Or, about 50% overvalued and needing a 33% decline to bring things back to normal.
But, hey, what's a $100,000 loss?
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