How Long Can Home Prices Keep Rising?
By: Moshe Milevsky
This is news only for the handful of Canadians who are not watching the real estate market closely. The average house price in Canada reached an all-time high of $371,000 this spring. In Toronto, the average hit $456,000 and in Vancouver it was $786,000, according to the Teranet - National Bank House Price Index.
Although there has been a slight price pull back during the last month or two, these market values are 100 per cent higher than a decade ago. Your house has more than doubled in 10 years, a compound appreciation of more than 7 per cent per year. This has occurred while virtually every other financial asset (other than gold) has declined in real value and housing prices in the United States have dropped by 30 per cent or more.
Canadians who own their home are watching these numbers with glee, while those still renting are filled with envy and remorse. They both wonder: “How long can this continue?”
I can’t tell you when the housing correction will come. But I can tell you that when it arrives it will be correlated with other bad news. And it’s the second correlation that worries me.
Median Canadian household income stands at roughly $55,000 after-tax. This number is what’s left in your bank account if all you had to pay were federal and provincial income taxes. The $55,000 has to cover the mortgage, as well as the cost of kids, food, clothing, transportation, utilities, retirement savings — and maybe some fun if there is any leftover.
Sadly, that pie has grown a mere 10 per cent over the decade, while housing prices have more than doubled. Who can pay these prices if wages and income barely budge? Luckily mortgage rates have declined over that time period, which has created an aura of affordability. But even the Economist magazine estimated last month that Canadian real estate is about 25 per cent overvalued. Don’t say you weren’t warned.
My bigger concern is that bad economic news tends to come in clusters. If and when housing prices decline in Canada, you will likely have other problems, as well. That is where your vulnerability lies.
Imagine you live in a medium-sized city in southern Ontario with a population of 100,000. Assume this city has two or three major employers. You work for a multinational technology company and your spouse works for a multinational insurance company.
If one or both of those companies runs into difficulty and is forced to lay off employees, there is a good chance you might have to move to another city, province or even country. You might not be forced to do this, but you might want to do it to take advantage of better opportunities.
The last thing you want is to have your mobility, flexibility and options hampered by a bad real estate market or, even worse, a house that is worth less than the outstanding mortgage. To make things worse, your RRSP, your company’s retirement plan, or your stock portfolio has lost a big chuck of its value.
The combination of all these events could mess up your long-term financial plans.
This is what statisticians call correlation. You might think the odds of losing your job, your RRSP declining, and your house tanking are all independent events, but they are not. The risks are correlated.
Here are two pieces of advice, one for owners and one for renters.
Owners: Don’t spend your home equity quite yet. Yes, that renovation might add value to the house, but will you really be able to get your money back when you need it?
If you have been diligently paying down your mortgage and have reached the milestones of 40 per cent, 50 per cent or even 60 per cent ownership, keep it that way. Don’t turn back the clock by spending equity in the hopes the 7 per cent continues indefinitely. Half of California made that mistake.
Renters: For the young renters with fragile careers, new jobs and daunting work prospects, remember that if and when the real estate market corrects itself, it won’t happen during sunny economic times. In all likelihood it will coincide with a constellation of bad news.
In those times there will be a huge premium on flexibility. You will want to load up the car and move to better pastures. One month’s notice to the landlord and you are gone.
Oh, and next time you are at a cocktail party, being teased about renting by some debt-laden MBA or hedge-fund manager, remind the antagonist that your personal balance sheet is deleveraged, liquid and safer. That should give them pause.