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What Can We Learn From The US About Real Estate Investing?
By Adrian Spitters and Win Wachsmann. The North American economy and real estate have gone through several stages in the last five years.
The US had a major recession beginning in 2008. Who and what caused it has been dissected by”experts” of all stripes and political persuasions.
What is obvious is that the Canadian economy has outperformed the US economy over the past five years.
From an outsider’s perspective, our banks did better than US Banks. Our employment rates were better than US rates.
Our government didn’t spend as much proportionally and as a result our deficit didn’t blow up like the US deficit.
The American homeowners saw trillions of dollars of home equity vanish as the sub-prime mortgage market collapsed.
In Canada, we avoided a similar housing bust.
All of a sudden Canadians were trumpeting their financial superiority.
Since housing starts, housing construction and housing related expenses (furniture, etc.) drive about 23% of the Canadian market any significant move will have a big effect on our economy.
However a change is brewing, and it’s not for the better.
American house prices are rising while Canadian housing starts and prices are stable or declining.
Robert Schiller, a Yale University economist who writes about US/Canada similarities says, I worry that what is happening in Canada is kind of a slow-motion version of what happened in the U.S.
In other words, Canadians can expect a housing price correction.
This is however, not a sky-is-falling article. The Chicken Little warning was based on the false interpretation of data. When an acorn fell on her head, Chicken Little believed the sky was falling and ran around hysterically warning everyone who would listen.
Our analysis of the current data allows us to make some cogent observations about trends.
So what trends are we talking about?
1. Average Home prices compared to average incomes
Have a look at this chart. (courtesy of The Motley Fool)
In Canada, home prices to income ratios have soared while in the US this ratio has dropped.
Most homeowners buy homes and pay mortgages based on their incomes. If house prices move up and incomes remain stable, eventually home prices will drop as well.
2. Home Buying to Rent Ratios
Have a look at this chart. (courtesy of The Motley Fool)
In the US the ratio has risen and then dropped.
In Canada, the ratio has risen 70% since 2000. The ratio is unsustainable. If new home buyers can rent for a lot cheaper than buying (with all its attendant fees taxes, maintenance, closing costs, etc.) they may re-evaluate. They may rent and invest or save the difference for a bigger down payment when house prices drop.
In and of itself it may not mean much, but taken together with the other factors, we may be in for a price correction.
3. Home buying trends
In the US home purchases soared based on a. low mortgage rates, b. long mortgage amortization times, c. high debt to income ratios and d. high demand from new and existing buyers. When these numbers changed, demand fell and trillions of dollars of home equity vanished, went poof and disappeared into this air.
The banks and mortgage brokers? They made out like bandits on the various buying and selling fees.
In Canada, home prices soared based on similar factors.
Now we see these changing as well a. mortgage rates are trending up, b. mortgage amortization rates have been decreased on CMHC insured mortgages and c. the demand for housing has stopped increasing in most areas of the country and even flatlined or decreased in others.
And what of economic predictions? The TD bank projects only a 2% increase in home prices over the next 10 years. That will not even cover inflation.
Can one predict the future in real estate?
No, but we can predict that the rate of home price increases (7-10% per year in some markets) over the past 10 years will not continue into the future.
Even though real estate value and pricing is primarily regional, if home values drop in Vancouver, Montreal and Toronto, the fallout will be felt in every region of the country.
The perception of homes being a safe, long-term investment option may be damaged. This perception may then reduce demand even more and a downward spiral may begin.
The Lesson or lessons?
Be prudent in buying and selling.
Don’t let the fear and the realtors’ “common sense” scare you into buying NOW, because prices can only go up.
Should you sell now and lock in all the profits you may have earned because your home appreciated so much over the last 15- 20 years? Perhaps. But examine all the ramifications carefully.
One thing we can learn from our American cousins is that any market correction will be painful.
However real estate does operate in cycles and will eventually begin to flatline and begin to rise.
Remember that in a down market, all sorts of great real estate value will arise.
To quote the Scouts, Be Prepared.
We’ll leave you with a quote from the Wizard of Omaha, Warren Buffet, “Be greedy when others are fearful, and fearful when others are greedy.”
By Adrian Spitters and Win Wachsmann
Adrian Spitters, FSCI, CFP, FMA
As a Certified Financial Planner (CFP), Adrian Spitters offers financial advice that focuses on investments, retirement, business succession, estate and tax planning in cooperation with his clients own legal and accounting professionals.
He can be found at www.theretiringboomer.ca
Win Wachsmann has been helping businesses improve their marketing and helping them get ready to sell their business. He doubles as an author, journalist, syndicated columnist, filmmaker and businessman who makes his home in the Fraser Valley of British Columbia. His articles and columns can be found in some of the finest offline and online magazines, journals and media properties.
He can be reached at firstname.lastname@example.org.