The photo above illustrates how the hot fashion colours included in my Spring Summer 2011 Forecast are appearing in the world of real estate. Click HERE to review that posting. In it you'll read several of my insights that serve as continued
dire forewarnings indicators for this coming season's market.
More recently, I'm hoping you enjoyed my amusing yet realistic parallels (well, I think so!) to the world of fashion in Part 1 of my 2011 Fall Real Estate Forecast. Click HERE to read my clever minx musings on Toronto's real estate market this Autumn.
Today you're in for an intense read, so my apologies in advance if you find this too much on the serious side for your liking. We're living in 'See Saw' times, and I'd like to share my point of view.
I began my real estate career in 1989 just as the Toronto housing bubble burst. Lucky me, eh? The magnitude of that housing market collapse was so substantial it took five years for the market to stabilize. Prices plummeted, with downtown properties being discounted by as much as 35 percent below their 1989 sale price peak in order to attract buyers. It wasn't until 1996 that the real estate market regained momentum, demand began to outpace supply, and property values began to increase. Real estate has followed a consistent upward trajectory ever since, except for the latter part of 2008 when the sub prime mortgage crisis paralyzed the global economy. During those heady few months of uncertainty Toronto housing prices plummeted upwards of ten percent, though they quickly recovered once government bailouts were announced (huh?), interest rates were lowered (really?) and consumer confidence returned (of course!). With our real estate market booming 14 of the past 15 years, it's easy to assume Toronto's housing climate will consistently increase in value. But for someone who experienced the five years prior do a major crash 'n burn, I have to confess I'm wary. Is Toronto's real estate market 'too good to be true'?
What Goes Up May Come Down
As a diligent realtor, I think it imperative I discuss both the risks and opportunities of a potential market downturn with my clients, while recommending they speak to their lending institutions about the ramifications of a market downturn. Especially as it pertains to their personal finances. I also take special care counselling my 'cash poor, income rich' clients as they're most vulnerable to a market downturn. If market values drop, first time buyers with small down payments run the risk of seeing their housing investment shift from an asset into a liability. Even a decline in prices by five or ten percent could obliterate their original down payment, leaving those property owners in a negative equity position. With zero equity, those owners may not be able to renew their mortgage when it comes due in the future. Why? Many lenders are reluctant to hold a mortgage for a sum close to the value of the dwelling. As a result, through no fault of their own and only by circumstance, the homeowners may end up being penniless and homeless. You only have to look at the United States, Ireland, and Spain (amongst others) to see evidence of this happening. A recent article in Report On Business by Derek DeCloet cites that one in six mortgages are insured by Canada Mortgage and Housing Corporation (CMHC) for buyers who put less than 20 percent down on their housing purchase. If the market shifts, the ramifications could result in a grim outcome for many.
While addressing this possibility to my clients is daunting at best, I feel it's better to bring these concerns to buyers in advance of their making a purchase. Everyone should weigh out the risks and explore potential solutions before they find themselves in trouble right? And if the rest of the real estate world is crashing while Toronto is not, shouldn't buyers take extra special care to face their worst case reality in case it does? As I wrote in my Spring Summer forecast back in January 2011, if it hits us (or should this optimist pessimistically say 'when?'), it will start with the condominium market.
There are an awful lot of condominiums being constructed which portends an over-supply. Huge sections of 'planned living communities' in the downtown core have high-rises whose unit ownership is dominated by local and foreign investors. Given there is a significant gap between the rising market values of downtown condominiums relative to the declining rental income they generate (due to the growing supply of condominiums for rent which appear to be outpacing rental demand), the moment the economy turns bleak and more investors need to liquidate we could experience a massive fallout in the condo market. If there are going to be any cracks in the veneer of our robust market, they're going to show up first in the condominium high rise market. Note, I'm writing about a specific type of condominium. For those who are living in a 'special' condominium which leans to architecturally unique, is of a good size, boasts a garden or terrace, has a panoramic view, or includes more than one parking space, you're more likely to retain your value. One key target market is all those boomers and zoomers who will be imminently down-scaling from big houses into something low-maintenance but house-like. Here's a recent article in the Wall Street Journal on the issue.
I have less concern over the downtown freehold housing market. The demand for houses is going to sustain itself for a long time, as there are three generations of Torontonians who grew up in the City who want to live downtown, each competing against all the new affluent professional arrivals who are keen to enjoy living in 'The City of Neighbourhoods'. Even though we may face a market correction, I think freehold housing in the downtown core will weather a market change better than anywhere else. Consider reading my August 2011 'Home Of The Month' blog post for further thoughts on this issue.
Time To Climb The Property Ladder?
A downturn in the market can also create opportunities. For homeowners with sufficient equity in their property, the best time to move up the property ladder is when prices are declining. For example, if prices were to drop twenty percent, your $500,000 three bedroom house would decrease in value to $400,000 while that four bedroom $750,000 house you covet will see its value decline to $600,000. For the financially prudent, upgrading your dwelling in a declining market can save you money. And for the shrewd minded, there's also the potential to realize a bigger discount when it comes to expensive property. The higher the price the smaller the pool of buyers, which means it can take substantially longer for a high-end property to sell. Compound that with a market downturn and you may be able to negotiate a substantial discount on a luxury residence distress sale. For some homeowners, a market correction could be advantageous in their move up the property ladder.
Stocks Or Locks? Which Should I Buy?
Given the roller coaster ride in the stock market this summer, more and more investors are asking me whether they should place their capital in bricks and mortar rather than capital stocks? As far as I'm concerned, stocks and real estate are equal opportunity investment vehicles. One investment is basically words on a piece of paper, the other essentially a pile of bricks and mortar. Each have a value subject to change based on the market conditions at the time it is traded. The potential risks and rewards of each venture pretty much equal the law of averages plus any special knowledge or skill you've acquired that will help improve your chances of profiting. In other words, if you reduce your margin for error by investing your money on what you know, you're increasing your chances to profit. Otherwise your 'investment betting' can be a lot like casino gambling. You win some, you lose some. How informed are you about your investments?
From my perspective, there is one fundamental distinction between real estate and stock. We all need and understand the value of shelter. Essential for physical survival and a place of safety for our psyche, having a roof over our head is part of the human condition. So unlike stock, owning bricks and mortar provides a return on investment while meeting our basic human needs, which I consider a pretty amazing 'value-added benefit'. It helps explain why 68% of Canadians own their own home. Add the advantage of not having to pay capital gains on the sale of your principal residence, and that your real estate investment will inherently appeal to a target market who are genetically wired to buy makes real estate, in my opinion, a safe prudent investment. But I'm no stock broker so I can't offer you a different perspective on the matter. I'm a realtor who knows bricks and mortar really really well. However, don't just buy 'any old house' and think it will be the right investment. There are several factors to take into account including your objectives and goals. Read my 'April 2011 Home Of The Month' post and 'The Income Property Proposal' for my insights on real estate investment.
Should I Buy & Hold?
I have always been a proponent of the 'Buy and Hold' mentality of investing. Once a hallmark of the depression era generation who moved into their first house purchase when they got married and exited 60 years later in a wooden box, that generation bought a property or three (maybe a cottage and a commercial building for their business) and held on to them until their golden years. For successive generations since, the buy and hold approach to property ownership fell out of favour. The rise and growth of a culture of consumption fuelled by the power and influence of the media commodified housing from a place of shelter into a lifestyle desire called 'home'. As housing became its own fashion economy, home buyers bought, upgraded/renovated/staged, and then flipped their residence on to the next. Climbing the property ladder by occupying increasingly conspicuous status markers satisfied the growing need to express oneself and live 'on trend', all while generating a profit.
It's still being done, but much like our current fashion forecasts I believe this trend is changing. As of late, more and more buyers are looking to eschew the status buy-in, bypass the herculean effort and expense of property climbing, and instead find a suitably-sized functional modest residence that can serve as a long term buy and hold family dwelling. In a prudent manner at an appropriate time, said property will be renovated and/or expanded. Those buyers who embark on this path will be doing custom renovations that, while more expensive, will provide greater personal pleasure and pay off in the long term. Our urban housing is going to be increasingly tailored to suit, luxuriously appointed with less 'big box store product' than ever. Buyers will eschew size for intelligent multi-use space, with more urban housing becoming two bedroom and den layouts with most space allocated to open concept entertaining. The days of living large are over, though this isn't at the expense of living in a bespoke jewel box. If you're a boomer or a zoomer, you may want to start thinking about cashing out of your over-sized house and splitting your capital into smaller properties you can buy and hold. This will diversify your risk and ease your opportunity for liquidity when required.
The Unpredictability Of Market Conditions
As you're reading this a technology just got invented, a product just got improved, and an occupation once common has just become obsolete. Tomorrow these changes will begin impacting market conditions. Oscillating in a state of flux and change at an increasingly faster pace, our future is becoming as wildly unpredictable as our bizarre weather systems. What this guarantees is there will always be market conditions to be concerned with. But barring calamity, I believe if you as a real estate buyer or investor steer the course, navigate prudently, and hold for the long term, you're pretty much assured a profit. Remember, the only people who 'lose' money on real estate are the ones who 'have to sell', not the ones who 'choose to sell'.
When asked about the future, anyone who has been in their business long enough to see a market cycle up and down should never be afraid to say "I don't know." I find the times we live in both fascinating and fearful. In Toronto's last housing bubble boom and bust there was no shadow banking industry that hedged their bets as much on the economy tanking as it succeeding, no sub-prime mortgage program that intrinsically linked the global stock market to most every country's property market (while everyone collectively played dumb) nor, as we recently experienced, could a country whose economy is sustained by war remove itself from perilous bankruptcy by granting itself a higher debt ceiling with the stroke of a pen. This very different world has left me, and a lot of savvy folk, perplexed. Which brings me to say that while I fundamentally believe Toronto has all the right ingedients to sustain itself in a positive profitable manner (we're a well-educated professional hard-working progressive liberated forward-thinking city with positive immigration), I have this niggly feeling that it will be another country's political economy that will take us down. These are big betting days. Wouldn't you agree?