Terrain of Calgary Real Estate Valuation – Price To Rent Ratios January 16, 2008Posted by DustinRJay in rental yields, valuation models.
Tags: bonds, calgary house prices, Calgary real estate, price to rent ratios, valuation models
In the previous post, I discussed how Calgary rental yields are less than many safe investments like bonds. I was interested in how the price to rent ratio compared in a historical perspective and what were the valuations like compared to previous real estate cycles.
A price to rent ratio is similar to the price to earnings concept which is borrowed from the equity markets. The idea is that house prices can be compared against the cash flow that can be generated from the property. Ergo, the higher the house price in comparison to the rent, the poorer the value of the asset.
RBC published a report in 2005 called “House Valuations Across Major Cities.” At the time of the report, it stated that price to earnings ratios for Calgary real estate had pushed “significantly beyond” late 1980’s levels.
The following is a graph of how price to rent ratios compare in Calgary. As you can see, rental yields are an underlying fundamental of house prices up until 1998, when house prices started increasing exponentially, but the trend for the rent index stayed at roughly the same as inflation.
The current valuations are roughly double the long term price to rent ratio. This information dovetails with my previous blog entry wherein I came up with a rental yield of 3.1% for Calgary house prices which is less than safe investments like bonds. A comparison against the long run price to rent ratio and the current valuations indicates that a more rational valuation would be 6.2% (slightly above low risk assets like bonds).
Therefore, caution may be warranted if buying, as house prices are roughly double traditional valuations.