The Wealthy Renter. Alex Avery

“interesting in theory, but not a real cost,” you should know that it’s not just me who recognizes implicit rent as a real cost. If you live in Switzerland and you own your home, you have to pay taxes on the implied rent you are receiving, as the owner of the house, paid to you, from you, the tenant in the house. Fortunately for Swiss taxpayers, they also get to deduct all of the costs of the house, including mortgage interest, from that implicit rent income they receive from themselves.

      CHAPTER 5

      The Canadian Housing Market

      Canada is a nation of homeowners, for the most part, with just 30 percent of households being renters. House prices have been rising rapidly in recent years, which means a lot of these homeowners have seen the value of their homes rise, lifting their net worth. However, we also know something else has been happening that a lot of these homeowners probably haven’t noticed: Their rent has been going up. And up a lot!

      Just because 70 percent of Canadians own their own home doesn’t mean 70 percent of Canadians don’t pay rent. What it does mean is that the vast majority of that 70 percent probably has no idea how much their rent has gone up in recent years, instead focusing on how much more their home is worth.

      Everyone needs to live somewhere. Canadians still need to live in apartments, townhouses, semi-detached houses, and single-family homes. But Canadians don’t need to own.

      However, more Canadians own their homes today than at any point in history — and this is true despite the fact that prices have risen considerably over the last few decades, to such a degree that many experts think Canada’s housing market is significantly overvalued. Why has home ownership been rising? Government programs encouraging home ownership are part of the answer. But I think a big reason for rising home ownership rates is that it has been a winning strategy. As I just noted, house prices have been rising sharply for a long time. And everyone who has owned has made out like a bandit! (Or so says the common wisdom.)

      Source: Canadian Real Estate Association (CREA).

      The good news is that Canadian homeowners have seen the value of their homes rise, creating significant wealth. The bad news is that house prices are high. If you haven’t heard, not only are Canada’s rising house prices seen as expensive by Canadians, but a good number of experts from around the world have voiced concern about our house prices.

       Robert Shiller, co-creator of the S&P/Case-Shiller U.S. National Home Price Index, Nobel laureate, and Yale economist, began calling for a correction in Canadian house prices in 2011.

       Goldman Sachs warned of an overheated Canadian housing market in 2013 and 2014.

      Some of the others who have expressed concern about inflated prices in Canada’s housing market include the following:

       The International Monetary Fund (IMF) — 2013, 2014

       Paul Krugman, Nobel prize–winning economist, City University of New York economist (2013)

       Pimco, the world’s largest bond fund manager, with $1.4 trillion under management (2014)

       Deutsche Bank’s chief economist, Torsten Slok (2015)

       Fitch Ratings, the global credit ratings and research company (2014)

       The Organization for Economic Co-operation and Development (OECD) — 2013

       Bank of Canada — 2011, 2012, 2013, 2014, and 2015

       Canada Mortgage Housing Corporation (CMHC)

      So what has gotten all of these global authorities worried about Canada’s house prices? Lots of concerning statistics and comparisons are being made to the U.S. housing market. Canadian house prices have risen at a pretty high rate over the past twenty years.

      Source: CREA, U.S. Federal Housing Finance Agency.

      House prices haven’t just been going up in absolute dollar terms, they’ve also been rising relative to incomes.

      Source: CMHC, CREA.

      House price increases have also outpaced growth in the cost of renting.

      Source: CMHC, CREA.

      At the same time, Canada’s per capita debt levels have risen to record highs, eclipsing the levels seen among American’s at the peak in 2007.

      Source: Statistics Canada, Federal Reserve Board.

      It’s hard to come to any other conclusion than that housing in Canada is quite expensive.

      Perhaps the most disturbing thing about the above chart is that the interest payments Canadians now make on all of that debt don’t include the implicit rent the 70 percent of Canadians who own their own homes probably aren’t even aware they are paying.

      Look at what these five charts we’ve just seen say: 1) House prices are at record highs in terms of dollar values; 2) House prices in Canada continued to rise significantly after U.S. house prices dropped nearly 20 percent across the country;

      3) Canadian home prices are at record highs relative to income, having grown dramatically faster than incomes over the past decade and a half; 4) Canadian home prices are at record highs relative to rents, having grown dramatically faster than rents over the past decade and a half; 5) Canadians are carrying dramatically more household debt as a percentage of income than at any time in modern history. If you take an objective look at those statistics, it’s hard to come to any other conclusion than that housing in Canada is quite expensive. There are arguments on both sides of the debate of whether house prices will keep rising or whether they will fall. Whatever happens, whether house prices fall or whether they remain expensive, the prospects aren’t good if you’re thinking about buying a home (unless, of course, you wait for a really large correction before buying).

      While it might sound a little counterintuitive, further increases to house prices in expensive cities like Vancouver and Toronto aren’t very good news for potential home buyers, as prices are already very expensive compared to historical levels. First-time homebuyers today are more saddled with debt than at any time in the past twenty-five years, leaving them committing to decades of payments with lesser prospects of higher prices in the future than earlier buyers.

      Beyond all of the Canadians who might be considering buying a home, this situation isn’t good for Canada. The 70 percent of Canadians who own their homes have huge portions of their wealth tied up in expensive assets that might deliver modestly positive returns over the next several years, or they might deliver negative returns. Neither would be as good as a cheap housing market in which the majority of Canadians could spend less on housing, and expect better odds of increases in house prices to boost their net worth and provide a higher return on their largest asset.

      The run-up in house prices had been looking a little more reasonable when U.S. house prices were rising alongside Canadian house prices in the early 2000s. At least we had company … until the U.S. housing market collapsed in 2006. The magnitude of that crash, and similarities between pricing levels and indebtedness in Canada today and the United States just prior to their housing crash, have many people questioning whether the gains in Canadian house prices can persist.

      Low interest rates have played a significant part in rising house prices, allowing each dollar of interest paid to cover more and more mortgage debt. Interest rates have fallen dramatically over the past twenty and thirty years. Using the same monthly mortgage payment, today’s five-year