Purchase power parity (PPP) is a theory in economics which helps us understand what the value of goods would cost across various currencies, once the exchange rate is factored in. The Big Mac Index1 is a modern take on this theory published by the Economist in the 80’s. The Big Mac Index (PPP) between two countries is calculated by dividing the price of a Big Mac hamburger in one country (in its currency), by the price of a Big Mac in another country (in its currency). This value is then compared with the current exchange rate; if it is lower, then the first currency is under-valued compared with the second, and conversely, if it is higher, then the first currency is over-valued.
Here at Ratehub.ca, we’ve devised our own purchase power parity index to examine the housing landscape of Canada. We call our theory, the “RH Index”. Instead of using Big Mac sandwich prices, we’ll use the home prices – to be more specific, the pricing of two-story, centrally-located, detached, three-bedroom, two-bathroom properties. The current average price of our “Big Mac home” is $390,1632. We’ll implement our RH Index against notable Canadian cities.
Next on the list is the beautiful city of Vancouver. According to MLS, they expect home sales to increase this year and next, by six and nine percent respectively. Forecasted, this translates to a 14% increase in the average price based on the strong first quarter this year3. Let’s see if we can find a home that meets our criteria:
MLS®: V900922, $998,000
It’s pretty rare to find a 3 bedroom, 2 bathroom property in downtown Vancouver that isn’t a condominium. And as outrageous as this price may seem, it’s actually quite common for a home of this type.
We are able to determine what the affordability of this home might look like using our mortgage payment calculator. By selecting the lowest rate of 3.59% when comparing Vancouver mortgage rates, we’re able to see that monthly payments are an incredible $4,024. The Land Transfer Tax in Vancouver amounts to $17,960 as part of the closing costs.*
*5-year fixed rate over a 25-year amortization with 20% down payment
Although we just started measuring our index against housing markets across Canada, we can say with confidence, that Vancouver is the most expensive and over-inflated city. It’s surprising, considering that the cost of living is only ranked 65th in the world according to Mercer, yet home prices continue to soar to almost New York City levels4. The average “Big Mac home” price is $390,163. We will be using this amount as our baseline “currency” to get our RH Index value.
How similar is this home when compared to the average Canadian price? What is the value of the home’s price tag versus the Canadian average price?
The implied purchasing power parity is $0.39 to $1
We divided $390,163 (the average “Big Mac” home price) by $998,000 (the “Big Mac home” in Vancouver).
This means that you are getting significantly much “less house” for your dollar when compared to the average. Therefore, we can say Vancouver’s housing market is over-valued. The actual average home price in Vancouver is $792,0005.
It can be difficult to secure financing in a market as expensive as Vancouver, so if you need sound financial advice, one of your best bets is to talk to a Vancouver mortgage broker.
1 Big Mac Index: http://www.economist.com/node/8649005?story_id=E1_RGQJDDV
2 Standard Canadian two-storey home: http://www.muchmormagazine.com/2011/07/canada%E2%80%99s-residential-real-estate-market-sees-sizeable-year-over-year-price-increases/
3 CMHC report: http://www.cmhc-schl.gc.ca/odpub/esub/64363/64363_2011_B01.pdf?fr=1311958258187
4 Cost of living survery: http://www.mercer.com/press-releases/1311145
5Average Home Price in Vancouver: http://www.livingin-canada.com/house-prices-canada.html