Playing the real estate sector

February 13, 20132 Comments

Real estate in the US has been staging quite a recovery since the 2008/2009 collapse. While actual housing prices in the geographical areas most affected have not yet fully recovered, the broader equity plays on the sector seem to be recovering quite well. Take a look at the iShares Real Estate ETF (IYR- US). The Index measures the performance of the real estate sector of the United States equity market, and includes companies in the industry groups, such as real estate holding and development and REIT’s.

Looking at that chart, it appears that the old highs hit during the 2007 “bubble” are quickly being approached. This level will provide some level of technical resistance as and when tested.

As for the Canadian markets, there are no diversified real estate ETF’s to monitor. Specific plays in REITS can be charted through the iShares XRE units.

I’ve asked Bruce Joseph to provide an outlook from his observations of the Canadian market. Bruce is a mortgage specialist who seems to have a decent understanding of the driving factors in the real estate markets right now. I thought you might enjoy reading a different perspective for this week’s sector view blog commentary. I hope you enjoy Bruce’s observations:

 

Canadian Real Estate by Bruce Joseph host of Real Wealth and Principal of Anthem Group (anthemmortgage.ca)

Given the recent headlines surrounding a Canadian real estate bubble, what should the Canadian home owner do regarding their real estate investments?

Real estate price fluctuations are highly localized. Vancouver has been labeled the most unaffordable city in the world, and the Toronto Downtown Condo market is showing speculative investing signs – similar to many American cities in pre-crash 2007. Toronto and Vancouver are showing classic symptoms of an asset bubble that occurs when prices exceed what incomes can support.

Home prices will soften this year in most Canadian cities, with extreme price deflation in Vancouver.

Canadian median incomes are the main fundamental driver of sustainable home prices. Income has not increased in real terms in the last decade, while real estate pricing has moved up in a meaningful way. Affordability always determines prices in long term – affordability has decreased in real terms. Artificially low interest rates have created an illusion of affordability.

The Canadian Government is taking on an active role to limit easily accessible & inexpensive mortgages. The former lower deposit requirements, in conjunction with low interest rates were a key component driving real estate prices higher from 2000-2008. Since 2008, the government has passed major restrictions “cool off the real estate market”. Some of the major changes include:

  • reducing amortizations from 40 to 25 years,
  • lowering refinances to 80% of the value of a home,
  • increasing equity demands for self employed borrowers
  • limiting home equity lines of credit from 80% to 65%.

The effects of these changes mean higher payments, lower mortgage amounts, and less refinances.  Such measures may lower demand for real estate by lowering the amount borrowers can qualify for a mortgage.

Over the last 14 years, homeowners perception of future real estate prices have been upwards. As this perception changes due to negative media headlines and government changes on borrowing requirements, new homeowners will adjust their expectations downward.  Going forward, this should equate to lower demand followed by lower prices.

It’s important to remember that Toronto prices are reasonable, at least relative to the median income statistics. Thus, the supply of homes being built in the GTA is in line with demand. However, speculative down town condo markets in Toronto and Vancouver likely represent an overvalued market at this time.

Mortgage Rates Forecast: Stable at historical lows.

The Canadian government has reinforced that they intend to continue keeping costs low while making accessibility difficult. There is no expectation of rates changing in the next year – however, mortgage rates may rise substantially for many borrowers as banks continually rewrite guidelines and restrict lending practices.

For this reason I recommend longer-term mortgages. With the right institution they are flexible low cost and protect the homeowner from renewal risk.

Advice for homeowners

1. Mortgage lending will continue to tighten and home equity may decrease in the future.  For this reason reallocating your debt for maximum cash flow, flexibility and term is best done well in advance. Discuss your debt allocation with your mortgage broker to ensure your hedged against renewal risk. This especially applies to investors who use leverage, business owners and those who are considering debt consolidation!

2. A significant driver of the Canadian economy is spending by consumers. The Bank of Canada has published papers on the wealth effect that is directly correlated to the equity in their home. When equity deflates, consumers spend less. Further debt has fuelled a huge portion of consumer spending. Subsequently, as debt is paid off, less spending occurs. The result may be further pressure on the speculative side of the real estate market.

 

Keith on BNN

Don’t forget to catch BNN this Friday at 6pm for my MarketCall appearance. If you have a specific stock you would like me to cover on the show, go to this link to submit your question:

http://www.bnn.ca/Shows/Market-Call-Tonight.aspx?Query=Keith%20Richards

2 Comments

  • Hi Keith: You have previously said that you sold off canadian financials due to seasonality, in particular the banks. Does this also hold true for the insurers or do you still hold or recommend holding the likes of SLF, MFC, etc. Love your blog; keep up the great work and advice. Thanx

    Reply
    • Hi Dave
      The insurance stocks look a bit better–I dont hold any, but MFC in particular looks like it still has legs.
      Be sure to email specific questions or call the BNN MarketCall hotline when I’m on at 6pm today if you have specific stock questions–happy to address them on the show.

      Reply

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