Calgary Real Estate Historical Yields March 25, 2009Posted by DustinRJay in Calgary real estate, rental yields, risk spreads, valuation models.
Tags: bonds, Calgary real estate, yield spreads
One way of evaluating assets is to compare them to a safe investment. Arguably, the safest investment in Canada is Government of Canada bonds. The biggest risk with holding a bond, is that it is subject to inflation over the term that you hold the bond, but virtually guarantees return of your capital.
The following graph compares the historical rent to price ratio for Calgary against historical long term bond yields. One of the benefits of real estate over bonds, is that the dividend (rent) can be expected to grow over time, and the asset value will appreciate over long periods of time. A bond does not offer any upside from the coupon rate. Therefore, it’s usually irrational that real estate, which has more risks in comparison to Government bonds should yield less. The following graph helps identify some of the recent price corrections including the 1982, 1991 and 2007 corrections.
[click above for larger view]
One interpretation is that given recent rental increases, lower bond yields, and lower house prices that the current rent to price ratio is more competitive than bonds, and therefore offers fair value.
Tags: bonds, commercial paper, recession, yield spreads
One of the tools that the Bank of Canada uses for forecasting probability of recessions is the spread between Government of Canada 10 year bond yields and 90 day commercial paper. This is a leading indicator of slower economic growth. The benefit of using a tool like this, is that if recessions can be successfully predicted in advance, monetary policy can be adjusted accordingly.
The paper “Predicting Canadian Recessions Using Financial Variables: A Probit Approach” concludes to say:
“Results in the paper show that, in comparison to other financial variables, the spread between Canadian long bonds and the 90-day commercial paper rate is best at predicting recessions in Canada.”
The following graph shows that the spread has been the largest since the 1990’s recession for about a year:
The past two recessions have marked peaks in the housing cycle in Calgary. As carrying costs are the highest since previous housing bubbles (see this post), it is useful to estimate the probability of a recession as a tool in forecasting the peak in the current housing cycle.
I am optimistic that Canada will avoid a recession at this point. However, I estimate that the next period will be the slowest economic growth that has been seen in more than a decade. I estimate that the probabilities of a Canadian recession are about the chance of flipping a coin three times and having all heads. Currently, Global Insight has estimated the probability of recession at 25% in Canada, with most other instutions forecasting less risk than that.
For those that are highly leveraged and unable to cope with an economic shock, there may be difficult times ahead…