Global real estate lessons for Canada

Spring’s the time of year when the housing market kicks into full gear. But just how sustainable is the sector? And is a home still a shrewd investment? With soaring prices, now’s a good time for Canadian home owners to look at what they can learn from inflated markets elsewhere.

“There are still many countries where residential real estate is the preferred means to create wealth,” says Robert Stammers, director of investor education at the CFA Institute. “In India, for instance, most people try to buy a home if they can because the adage there is ‘real estate never goes down in price.’ However, this was the exact same sentiment we saw in the U.S., which eventually led to the market downturn.”

Remember, you’re an investor

When American lenders began giving out 100-per cent loan-to-value mortgages and homeowners used leverage to increase the size of their purchases, Stammers explains, it was a signal that homes were becoming overvalued. Home owners can get into trouble when they forget that they’re investors.

“The main lesson Canadians should take away from the U.S. housing crisis is the importance of really understanding real-estate fundamentals so you can identify when the market may be losing discipline,” Stammers says.

“Since many homeowners didn’t see themselves as real-estate investors, they didn’t take the time to understand how real-estate values were impacted and what that meant for the equity in their homes. Since the crisis, U.S. investors have become a lot more cautious about the financial risk and the level of exposure they’re willing to take on a home purchase. This is healthy behavior, and it’s one that Canadians should look to emulate.”

It may sound basic but it’s often overlooked: choose a property that fits within your means and comes with a realistic repayment schedule.

The need for balance

What came to light during the U.S. housing crisis was the fact that so many Americans held just one asset in their portfolio: the equity in their home.

“Intentionally or not, these individuals were risking their entire wealth on the economic health of the housing market,” Stammers says. “What most home buyers failed to realize was that anyone who buys a home is an investor, and as an investor, building a balanced and diversified portfolio, one that’s not overly exposed to any one asset class, is imperative. The problem in the U.S. then and in Canada today is that many home owners … fail to invest in other assets that would minimize their risk.”

Hong Kong is one example of an overinflated market; so are Toronto and Vancouver.

“With the heated real-estate markets we’re seeing across Canada today, many buyers are throwing their savings into a home without factoring in the potential ups and downs of the economy and the fact that a significant portion of their savings could be lost if the value of their home depreciated,” Stammers says.

“Right now people are valuing homes in an environment of low interest rates and low inventory,” he adds. “If and when interest rates rise, it will increase the cost of taking out a mortgage. Couple this with an increased housing inventory, and there’s no reason that the value of one’s home won’t drop. It’s straightforward economics. Similar to what we saw with the U.S. housing crisis, some Canadians are pushing their savings into homes priced for today, but not taking into account their future value for tomorrow.”

Put sentimentality aside

Like other assets and investments, there are good and bad potential purchases when it comes to real estate.

“Emotion has little place within investment decision-making, but unfortunately many people get emotionally tied to real estate,” Stammers says. “Individuals who think of their homes as just one investment asset in a larger portfolio are in a better position to make decisions about downsizing for retirement or moving to an area with more attractive investment fundamentals.

“People need to understand that it’s the land under their homes that is appreciating, which depends on the supply and demand factors in their local market,” he says. The school system in your area, local amenities, and development of new housing are elements that influence a home’s value. “If we’ve learned anything from other countries, it’s that real estate prices fall due to macroeconomic issues and the loss of discipline by investors and lenders.”

Don’t be greedy

“Investors tend to get into trouble when greed takes over and they risk too much to engineer returns the market won’t support,” Stammers says. “As we learned watching the U.S. situation a few years back, when the market moves against you, so does the leverage on your investments.”