Is too much of your wealth tied up in the housing market?
Canadians looking with increasing concern at a wobbly housing market received plenty to feed their anxieties this week. On Tuesday, the Canadian Real Estate Association released nationwide data on housing sales and prices for December — and the numbers were downright ugly.
The volume of homes sold in 2018 was down 11 per cent compared to 2017. The average price of a home sold in Canada, which is skewed by big and pricey markets like Vancouver and Toronto, fell by around 4 per cent, the first drop since 2008 and the largest since 1995.
But even when looking at the so-called MLS home price benchmark, a more representative gauge, prices “scratched out a modest 2.7 per cent gain,” BMO economist Robert Kavcic wrote in a note to clients shortly after the release.
The year-over-year comparison is further skewed by a spike in home purchases that occurred in late 2017, as buyers rushed in to close contracts before the new federal mortgage rules came into effect on Jan. 1.
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Even so, though, the report is added evidence that home prices, to which Canadians have pegged so much of their fortunes for over a decade, are now stuck in neutral — or falling — in much of the country.
For now, many analysts maintain that the potential for a steep and widespread housing market downturn remains low. But if you find yourself monitoring the headlines with crossed fingers these days, it’s worth asking: How much of your wealth should be tied up in real estate? And how much is too much?
That question has always tripped up both homeowners and economists because a home, unlike a stock or a bond, is both an investment but also something we need and use every day.
Is your home a good investment?
Many people think of their homes as a good investment — and it’s easy to see why.
“Generally speaking, we try to have asset holdings that make us as much money as possible after tax, while minimizing the risk we face,” says Thomas Davidoff, a professor and housing expert at UBC’s Sauder School of Business.
At first blush, owning a home in Canada looks like a good investment both in terms of making money and saving on taxes. The benchmark home price has roughly doubled between 2006 and 2018, rising from around $300,000 to about $600,000. That’s as much as you would have made investing in the financial market with a respectable 5.5 per cent annual return for 13 years, Global News estimated using the Ontario Securities Commission’s compound interest calculator.
The perks of owning a home are even better from a tax point of view. If you bought, say, $300 worth of Apple stocks and sold them for $600, you’d have to pay some tax on your $300 profit, unless you were holding the funds in a registered account like a registered retirement savings plan or tax-free savings plan. But if you bought your home for $300,000 and sold it for $600,000, you generally wouldn’t have to pay tax on that whopping $300,000 gain. It’s a huge tax break for homeowners.
Put simply, “owning a home is favoured by the tax system,” Davidoff said.
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When it comes to risk, though, the comparison with stocks and bonds is less flattering. With investments, it’s always a good idea never to have too many of your eggs in one basket. Ideally, you’d probably want to have 30 per cent of your money in housing and 70 per cent in a mix of stocks and high-quality bonds, said Davidoff at UBC’s Sauder School of Business.
Indeed, that’s not too far from what the ultra-rich choose to do. According to a 2018 report by property agency Knight Frank, multi-millionaire families in North America have 34 per cent of their wealth in real estate, excluding their principal home.
Of course, such an asset allocation isn’t really feasible for common mortals. Most of us need a place to live and are forced to use much of our money to buy one.
But having all or most of your wealth tied up in your home is a bit like betting everything not just on the stock market but on a single stock, argues Benjamin Felix, associate portfolio manager at PWL Capital. Sure, home prices have historically been less volatile than stocks, but your fortunes are nonetheless tied to one house and one local real-estate market.
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In addition, homes come with a lot of added expenses compared to stocks, like property taxes and utility bills, Felix notes in a series of popular YouTube videos.
And several of those outlays can be difficult to anticipate, Davidoff said. Maintenance work can be both pricey and unpredictable; your mortgage payments may go up along with interest rates; and you can’t know in advance how much your home will be worth in the future.
“And price growth is a negative against the cost of owning,” Davidoff noted. In places like Vancouver and Toronto, for example, “people who bought houses 20 years ago have had lower housing costs than people in cheap markets, who haven’t see as much appreciation — in fact, people in [the hottest housing markets] have had negative housing costs, because they made money owning their property.”
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But housing market research introduces the question of whether those large price gains also come with an added risk of steep downturns.
In a recent report, for example, the International Monetary Fund notes “a striking increase in house price synchronization among 40 countries and 44 major cities in advanced and emerging market economies over the past several decades.”
Among those major cities are Vancouver and Toronto.
“Rising housing valuations since the global financial crisis raise the spectre of a simultaneous decline in house prices should financial conditions reverse,” the report adds.
How to mitigate risk
While few homeowners can avoid sinking a sizable chunk of their money in their house, there are ways to mitigate risk.
One consideration is whether you should really be investing in an income property when you already own a home.
“Then you start to be really exposed to real estate and are missing out to exposure to equities in all kinds of industries,” Davidoff said.
Another thing to think about is the possibility that the value of your home and your income will decline at the same time. While that risk exists for everyone, as housing downturns and recessions often happen at the same time, it’s higher for some people.
For example, “if you work in the energy sector, and you also have a home with the price that’s going to be determined by what people in the [industry] can pay, you’re not only putting a lot of your wealth into a single asset, but [the value of that asset] is then going to go up and down with your earnings,” Davidoff said.
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Something similar can arguably be said of Canadians whose income is tied to the real-estate sector.
One way to reduce this type of risk would be saving in cash for a generous rainy-day fund instead of counting on tapping in your home equity for emergency.
Another concern is how much debt you should take on to buy a house. After all, while all investments involve risk, placing a bet with borrowed money is riskier.
“If you’re buying a home with 10 per cent down, now you have a 1,000 per cent of your wealth tied up in a single asset,” Davidoff noted.
The obvious advice here is buy what you can afford.
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Finally, try to buy a house you can see yourself living in for a long time, said Felix.
Homes, as with any other investment, “shouldn’t concern a long-term owner.”
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