We often see advertising and hear radio commercials screaming that this is a good time to buy real estate. You can even read articles explaining why this is the case. But anyone with a trace of intelligence can immediately understand that those are written or paid for by realtors and, therefore, completely disregard them. So is this a good time to buy real estate?

In one of our previous articles we described a methodology which you can use to compare buying a house vs. renting it from a purely financial standpoint. This is easy to do but not sufficient. For example, it may be cheaper to buy a condo than to rent it. But if you look at the total price rather than your monthly expense, the result may be different. For example, the average house price in Vancouver is more than $100,000 lower than it was a year ago. This means that by not buying a house last year I saved over $100,000, which easily offsets a few hundred dollars I overpaid in rent during this year. If next year it will be lower by another $100,000, it makes sense to wait a year, even if you are paying more in rent.

If you are considering buying real estate as investment, you have to consider its long-term and short-term potential. From the long-term perspective, the value of a housing unit is simply a function of income of the population in the area. Historically, the median income multiple has been around three. This means that in an area where median household income is $100,000 an average house is worth around $300,000. As incomes go up, so do the home prices fluctuating somewhere around this long-term trend. In the recent ten years many areas in the world have seen an unprecedented housing bubble with median income multiples reaching levels as high as 12. This bubble has already started deflating with prices in some areas falling by as much as 50 per cent and more. In Canada, this process has just started and we haven’t seen any significant price reductions yet, with a few exceptions. If you live in Vancouver, BC where median household income is around $58,000, the sustainable equilibrium price for an average house is around $178,000. The actual price today is around $600,000. So is it a good investment? Probably not. But if you live in Windsor, ON where median income is around $62,000 and an average house is now worth well under $100,000, the picture is completely reversed and real estate is a great investment.

As a short-term investment, real estate is generally a bad option due to its low liquidity. This doesn’t apply, however, to market boom situations, but our real estate boom is over and is not coming back for at least ten years. Therefore, you should primarily focus on the long-term investment potential of real estate which is easy to determine by simply comparing the current prices to the median income in your area.

Nikolay Sisan is a Certified Financial Planner and freelance writer in Vancouver.