Hilliard MacBeth, director of wealth management at Richardson GMP recently suggested that he sees Canada’s residential real estate boom as a classic bubble. The basis of his argument is that, historically, residential real estate (not to be confused with commercial real estate) has been held as lifestyle purchasing. It’s a place where you live or vacation (your home, cottage, snowbird residence etc). The more recent trend (by historical standards) of retail investors has been to invest in residential real estate for capital gain potential and income investing. MacBeth’s argument is that, like other bubbles, when retail investors (aka “dumb money”) move enthusiastically into a nontraditional asset class as an investment, or into an unfamiliar area of investment such as the Dutch tulip bubble of the 1600’s, the Japanese mutual fund exuberance in the 1980’s and the tech & subprime/oil rally of the past decade, it typically suggests bubble conditions. You can see his interview here.
Statistics Canada reported in September that the ratio of Canadian household debt to disposable income has reached 167.6 per cent — the highest it’s ever been – and the majority of that debt is mortgage debt. Canadians’ household debt is bigger than the country’s economy! To me, this is a statistic that may pose a problem for Canada’s real estate prices in the future. One can only borrow so much…
I note that housing starts in the big Vancouver and Ontario markets approached their 2008 all-time highs in 2015. Since the government tax on foreign property investments, Vancouver has slowed considerably (33% – 59% drop in sales from Feb-September of this year, yr/yr) . But Ontario sales have continued to increase. National Bank economic research suggests Vancouver (and surrounding areas) should experience a 10-20% decline in prices over 2017. They expect a smaller average decline in Toronto prices by about -3%. The chart below shows us this year’s housing prices in Toronto and Vancouver.
Comparing the risks
While it is arguable that the stock market is as overvalued as real estate, the stock market has a few advantages that I see when facing this dilemma. First, the cost of maintaining a stock portfolio – all things being equal – excludes those costs surrounding real estate investing. We do not pay property taxes, condo fees, maintenance or upkeep on our stocks. Another advantage of stocks is their immediate liquidity. If one notes a change in trend in their stock portfolio, liquidation can usually be done in a matter of minutes – as can paring back on one’s exposure.
There are no immediate markets to liquidate a residential real estate investment (REIT’s aside) – your property may sit on the market with a “For Sale” sign on the lawn (or listed with MLS) with no activity on it for months – with a revolving “New Lower Price” sticker to keep pace with the falling market. This is unfavorable in a rapidly falling market, as I might imagine some Vancouver sellers are, or will soon be noticing.
Hedging ones risk within a residential real estate investment is nearly impossible. Stock risk can be offset by hedging with inverse ETF’s or options. Those hedges can be removed on a moment’s notice with minimal cost and hassle. So too is diversification within residential real estate (non REIT) investing. Diversifying through 20 stocks and commodity plays in different sectors and economies is pretty easy. Monitoring them for sell signals is simplified through technical analysis. Residential real estate is typically a very concentrated investment strategy.
Both stock and real estate investments can offer yield/ income. Both can be leveraged to amplify of those yields. However – No unruly tenant can forego payments and hide behind provincial laws in a dividend paying stock portfolio. If a corporation changes its dividend policy or runs into problems, you can immediately evict it from your portfolio with no emotion or legalese involved.
While I will never argue against holding a diversified portfolio, I do believe that investors should be cognisant of the current risks surrounding real estate investing. For my money, I will always look for assurance that a bad investment can easily be disposed of – bubble or not. For that reason, it is my opinion that investing in residential real estate are perhaps less enticing than many retail investors believe.