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.
In Quebec, there has been 6 months of increase in foreclosures. Nothing exponential, but an increase nonetheless. Even in Quebec City, which experienced a massive price growth since 8 years, many houses in the best areas, have sat on the market for over a year. My sister, who purchased a 3 bedroom house recently, put in an offer 100k under asking and… it was accepted.
Re your sister’s purchase….whoa!!
Great article Keith! What is troubling besides our debt levels, we have a perfect storm brewing for some time in the GTA. An influx of 150,000+ new Canadians into the GTA annually (and growing) a shortage of available land to build, the Premier just announced she will NOT follow BC’s tax levy on foreign owned housing, and the B of C policy on holding (or lowering) interest rates thus depreciating the C$ to entice even more foreign investors holding US$. Vancouver prices need to drop and Toronto will probably play catch up for a while and prices will hopefully “moderate”. The problem is too many people are in this game, and if you want to leave early, the alternatives are limited. Whenever this party does end, its going to get ugly for “everyone”….
Sorta like the stock market. Musical chairs….
I just wanted to add the sentiment that as a young professional looking at buying a house/condo at the current prices is really daunting. I make decent money and even if mortgage rates are low and the payments look reasonable over a long time span, I am apprehensive to go into that kind of debt. Especially when the value of what I’m buying is being put under stress and who knows what interest rates will look like 15+ years down the line. Currently renting, hoping to one day own something of my own. Any advice to the younger crowd?
Bob–I tend to agree with the GMP guy in that real estate should first and foremost be for lifestyle (watch his video if you haven’t)– as a renter, you lose more than as a buyer unless prices plummet really hard–even if your house goes down in value in the short run, you would lose money paying rent too–perhaps it may be worth it to wait and see what happens next year re prices, but I feel that if you DON’T look at a house as an investment and think of it as what you want to do from a lifestyle point of view (beyond accumulating the money that would have gone into rent and directing it into something that some day you will own) –you will be ok. The other trick might be to avoid the hot spots like Toronto and Vancouver -particularly condo’s. Look at less popular regions and take the train to work!
Yes but you can get cheap leverage, no? You can put 5 or 10% down and borrow the rest from the friendly banks, then as the property goes up by 10 or 100% you get huge leverage. You can make way more money from this than investing in stocks.
Also Ive been wondering why the banks are unaffected by whats going on. At the end of the day, its the CMHC that insures the mortgages of the nation to the tune of $600B today.
I dont know can the taxpayer afford $300B+ in the event of a meltdown?
“Yes but you can get cheap leverage, no? You can put 5 or 10% down and borrow the rest from the friendly banks”
You can get cheap leverage with stocks too. You could have bought 300k of CAR.un (entry = 22.00) with 2% interest (tax deductible!) and watch it go up 55% to 450k (exit=33.00). Of course, likes a house, it depends on your entry: will a 700k 50 year old semi-detached in the area of Lansdowne/Wallace go up 50% over the next 3 years? I’d rather bet on a diversified REIT.
“as the property goes up by 10 or 100% you get huge leverage. You can make way more money from this than investing in stocks.”
In Vancouver, yes, it’s been the case. Not in Quebec. In Quebec, prices have been flat or down. Houses sit on the market for months. Even in Vancouver, I’d be careful starting next year. My cousin just sold his house in Vancouver for 80k less than he bought it for. He got laid off so couldn’t “sit” on his asset. It all depends where you buy and at what price.
I agree with everything you say in this blog, in spades. Except for one thing…taxes. A stock portfolio does indeed attract taxes – on the sale of the stock and on dividends. RRSPs and RRIFs are no exception for they also attract taxes ultimately. The one exception are TSFAs but these are started with after tax money. Would these equal property taxes on primary residences? Maybe, depending on the number and size of the trades.
Fred–I used taxes on profits as neutral because there are also taxes on the sale of real estate and on the income (net) from rental. I am strictly focusing on investing in real estate–not on home ownership. So buying a condo to rent out is the same from a capital gains perspective (worse for income on real estate–you don’t get dividend tax credits on the income)
I had to go back to comment on your blog, as a tweet this morning makes it very timely:
“@EQBank says > 1/2 of its 2016 YTD prime single-family securitized mtgs would not qualify for insurance under the new rules. Src: RBC”
HALF their clients do now qualify. That, is crazy. Thousands of borrowers that could not handle a 2% rise in rates. I hope a journalist can find out who their clients are typically. If they are condo buyers, like I think… Toronto condo investors could be in for a surprise.