Price to Rent Ratios

Obviously there are no lack of indicators and ratios out there, we've looked at several here over the months. Some in my opinion are fairly useful, like absorption rate... others I feel are as useless as tits on a bull, like sales to new listings.

In any case, today we'll look at another one... price to rent.

I briefly took a look a historical rents awhile back, but have since came across a better data set (well, same set actually but a longer horizon, and in cases like these, the more data the better). To set the groundwork, here are the rents for Edmonton and Calgary going back to 1990.

The two cities have tracked fairly similar patterns. Rents were relatively stagnant in the early 90's, then in 1997 they started about a 5 year run up then plateaued again through 2005, after which they again took off. These figures are from October of each year for those curious.

As the name implies, the other part of the price-to-rent ratio is price. Creative name, I know. Anyway, here are the residential averages and condo averages for each city taken from October of each year.

Now our rent variable is that of 2-bedroom apartments, so obviously the condo average would be the better comparison other. So why did I include the residential average, well, it's because I only had Edmonton condo averages going back to 1999, so I had to do some estimating to fill in the '90-98 portion.

For the three years, '99-01, the condo average was generally around 70% of the residential average (FWIW, in recent years that ratio has been closer to 75%). So going backwards, I used that proportionally. As prices were very stagnant over that period I felt that was an acceptable method... but if you disagree, I have also done these ratio's using the residential average.

No such issue with the Calgary number as I had the full set. It is interesting to note that the Calgary condo numbers track extremely close to the Edmonton residential number. Also of note, the Calgary condo average is usually closer to their residential average (85%) then in Edmonton (as discussed in the prior paragraph). Why is that? I'm not sure, but perhaps condos are more prevalent in that city and thus make up a larger portion of the market.

Here we see the price-to-rent ratio for condo's to two bedroom apartments in our respective cities (or, in case you didn't like how I derived this as explained earlier, here is the graph using the residential average to two bedroom apartments, in any case, they yield very similar curves).

How this is calculated is to take the price, then divide it by the monthly rent multiplied by 12 (in other words the amount of rent paid in a year). Interestingly we can see that Calgary generally seems to track 2-3 points higher then Edmonton. So while Calgary prices and rents are both higher then those in Edmonton, their differences are not proportional.

Looking at the trend, through 2001 in both cities the ratios remained relatively consistent... but from '01 through '07 they steadily increased at a rate of around 2 points per year. A reflection of the big run up in prices, but interestingly this trend was very much evident long before prices really exploded in 2006.

We can also see the effects of the drop off in price, as the ratios for both cities fell off to the tune of about 4 points in 2008, reflecting the drop off in price while rents continued to go up as evident in the earlier graphs.

Both these upwards and downward movements display how rents are generally more 'sticky' then prices, in both directions. This should not be surprising though as sale prices concern only one-off transactions that take place that month, while rents are determined by ongoing agreements/relationships/leases that can be made months or even years earlier.

One of our regular commenters Chris, aka CM, mentioned a good article concerning the price to rent ratios witnessed in many bubble cities in the United States at their peaks. One passage reads.

Throughout the 1970s, ’80s and ’90s, the average rent ratio
nationwide hovered between 10 and 14. In the last few years, though,
it broke through that historical range and hit almost 19 by the time
the housing market peaked, in 2006.

And while home prices — and rent ratios — have always been higher on
the coasts, they reached whole new levels recently. In the Washington
area, the ratio went above 20. In Boston, New York, Los Angeles and
south Florida, it topped 25. In Northern California, it approached 35,
higher than it had been in any city, at any point on record.

So it's interesting to note some of those figures with our findings above. Firstly, that the nationwide ratio in the US was generally between 10-14. This would certainly describe Edmonton's situation until the run up... and would largely also ring true for Calgary though they were closer to 15, so they were close.

In any case, Calgary would be at the high end, while Edmonton would be right in the mix. So it's interesting to compare the peaks, Calgary at 25.4, and Edmonton at 22.9. These ratios are very close to those experienced in Boston, NY, LA and south Florida.

While all four of those US cities experienced bubbles, those experienced in LA and south Florida were far more extreme, and both have suffered very badly in the aftermath of the bubbles bursting. This could also indicate trouble for us, as the magnitude of the bubble experienced in Edmonton is much closer to those witnessed in LA and south Florida moreso then Boston and NY... the bubble in Calgary was somewhat in the middle ground, significantly lower then the former two, but much high then the latter.

Thus, our price to rent ratio is another indicator of just who severe a boom we experienced... the question is, how bad will the bust be?

Also just want to do a quick appendices on another measure I found. These are the rented accommodation indexes, and owned accommodation indexes for Edmonton and Calgary.

These are part of StatCan's Consumer Price Index. Not entirely sure exactly what and how many factors are included in these measures, but all things being equal, I thought they were worth a quick look.

It's interesting to see how they've evolved since 1971. For both cities the two figures have tracked very closely up until 2006 when the rapid run up of real estate prices caused a significant decoupling. Rented actually have largely continued their traditional course, but Owned underwent a massive spike, to a magnitude never witnessed before.

It's also interesting to note that in both cities in the early 70's that the Owned index was actually significantly lower then the Rented index.