About a year ago, on this very blog, I began to pound the table on a real estate correction that I thought was imminent in Canada. All the signs were there- frothy valuations, (currently at over 5 times average income) record low interest rates, a sputtering economy, as well as two markets that are, by all metrics, ridiculously overvalued. Those markets are Toronto and Vancouver, in case you’re wondering. I’m way too lazy to click back, but I may have even called it a bubble.
A year later, my predictions haven’t exactly come true. While some markets in the west have been somewhat stagnant, markets like Toronto and Vancouver have surged on ahead. There are more listings out there, and more buyers are waiting until they make the plunge into homeownership. The market has transformed from a seller’s market to more of a buyer’s market, but we haven’t seen many price declines in many markets. The bottom line is the housing market isn’t doing too badly.
I still stand by my prediction that the housing market will correct in Canada, especially in Toronto and Vancouver, with the condo market getting hit especially hard. Record debt levels combined with increasing interest rates cannot be good news for the average homeowner. The U.S. market collapsed with the average income to home price ratio at 4.6, below where Canada currently is.
As with any overvalued market, calling the top is incredibly difficult. Fundamentals can be out of whack for years before everybody realizes something is wrong. Often, there’s some sort of extraordinary event that serves as the catalyst for the market collapsing, like the falling of Lehman Brothers and Bear Stearns during the most recent financial crisis. Often, by the time the media gets around to reporting on a bubble, the bubble has already burst.
If I’m of the opinion that the real estate market is overvalued, then shouldn’t I advocate away from home ownership? Maybe I should take it a step further and suggest that baby boomers sell their real estate and rent for the rest of their lives. If real estate prices are bound to go down, then isn’t that just good planning? Someone can diversify their real estate proceeds into bonds and other asset classes that provide income.
If somebody isn’t willing to sell their home and uproot their family, then perhaps I should be telling them to delay buying a home for as long as possible. They should wait for the inevitable decline and then pick up a cheaper home once prices decline. Oh, if only things were that simple.
If someone lives in a house that’s paid for, there is value in that. Somebody gets to live without having the pressure of having a mortgage or rent payment. So many people work hard for a long time to pay off their mortgage because there’s value in not having a payment to worry about every month. This is extremely important to all sorts of people. Having significant equity tied up in a home has value because it lets people live without a mortgage payment. Everyone has to pay for a place to live.
Meanwhile, we have younger folks who are looking to buy their first house. Depending on the people, some either have decided to settle down in a particular place or they’ve decided they’re going to stay somewhere for a few years. I absolutely advocate people buying a house if they’ve decided to settle down somewhere. Buying can serve as a psychological step into becoming more of a grown up. Owning a home can further entrench someone in the community they buy in, as well as causing them to take pride in owning something. When someone reaches a certain point in their life there usually becomes a desire to settle down and home ownership is usually included.
So to summarize, if someone is feeling the itch to own a home, I still think they should buy one, assuming they’re going to be in one place for longer than a few years. If someone is looking to own for the guaranteed profit, then I think they’d be better off renting.
So Who Should Sell?
There are only two groups of people I think should sell.
The first group of people are the baby boomers who are thinking of selling anyway. Their motivation isn’t usually fully about cashing out equity, rather they’re looking at simply downsizing. They sell their big house, buy a condo or townhouse and bank the rest of their equity. They reduce the exposure to real estate in their net worth, as well as getting a place that makes more sense to them going forward. This is a good strategy and I think people should do this.
The other groups of people I think should sell are those people who loaded up on investment real estate during the ride up. I cannot stress how dangerous it is to borrow money at a 10:1 ratio on a property that cash flows only a couple hundred bucks a month. I beg those people to sell as quickly as they can before something inevitably happens. Leverage increases risk, plain and simple, and if you combine leverage with a crappy market, you can be in a house of pain.