Retirement and Risky Real Estate

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It’s hard to think about decreasing property values when listing prices are through the roof, but failure to understand and plan for the inevitable “bubble” burst could leave you high and dry, especially if you’re rounding the bend on retirement. According to Ben Rabidoux, a correspondent for the Globe and Mail, the next decade will likely be one of the most tumultuous in Canadian real estate history. Here’s what you should know.

Trouble Always Comes in Threes

According to Rabidoux, there are three main factors that Canadians need to keep in mind when it comes to their real estate nest egg:

1) Home Prices Will Fall

Housing prices have outpaced income growth by two or three times in most Canadian cities over the past five years. Rising interest rates will put an end to this trend.

2) Stricter Mortgage Protocols

The availability and relatively low cost of mortgage credit has played an important roll in the current housing boom. The implementation of stricter mortgage underwriting practices suggests that credit conditions will tighten in coming years, reducing the number of qualified buyers.

3) An Aging Population

A 2010 study by the Bank for International Settlements found that demographic factors contributed “positively to real house prices in many countries in recent decades.” Common sense shows that the young save for old age by purchasing assets (i.e. homes), while the old sell assets in order to finance their retirement. As such, the asset purchases of a large working age generation drives the price of assets up; when this population ages, and the subsequent generation is relatively small, asset prices decline.

Problems on the Horizon

While young investors and first time home buyers will have their choice of affordable real estate, this demographic shift will cause some obvious problems for Canadian near-retirees who have been planning on using the equity from their home to at least partially fund their retirement.

Current demographic trends suggest that the greatest amount of pressure will be felt on the higher end of the housing market. As baby boomers downside to more age-appropriate dwellings, the demand for larger homes will drop significantly. What’s more, the square-footage of the average Canadian home has grown considerably over the past 35 years, even though the average household size has fallen by a third in the same time period. This is a trend that simply cannot persist, leading to larger homes eventually falling out of favour.

As such, the implications are clear: if you’re holding onto your property in order to squeeze a little extra capital prior to selling, you’re flirting with disaster. Now might be a better time to put your home on the market, secure a low mortgage rate, and downsize to a more affordable option.

Which Markets are the Most at Risk?

The Canadian housing market is extremely regional in scope. As such, some markets will be far more vulnerable to a price correction resulting from a demographic shift. Not surprisingly, experts believe that Toronto and Vancouver, Canada’s hottest areas, will be the ones most apt to crumble.

It’s an Issue of Fundamentals in Vancouver

The latest data out of Vancouver already hints at a slowing market. While active listings are near all-time highes, sales are at decade lows. What’s more, there’s a growing disconnect between resale prices and real estate fundamentals (rental prices, incomes, and inflation-adjusted house prices).

When rents increase at a slower rate than resale prices (as is the case in Vancouver), it is often a symptom of cheap credit and irrational spending. When interest rates begin to climb, the Vancouver market will take a significant hit.

Inventory Overload in Toronto

There are currently 53,000 residential dwellings under construction in Toronto, roughly 48,000 of these are condo units. According to condo research firm Urbanation, there were roughly 15,552 unsold Toronto condo units on the market as of the end of March. With so much construction in the works, strong demand for new units is crucial. Without it, prices will be adversely affected. Right now, the vast majority of condo units are being purchased not by end users, but foreign investors. These buyers are banking on units to continue appreciating in value in order to make money, which is unlikely given the current economic climate.

While a price drop driven by demographics will be felt across the nation, some areas are far more at risk than others. As such, the message for sellers and buyers in markets like Toronto and Vancouver is clear: tread lightly if you’re looking for an investment. End users looking for a long-term home are in a much better position to secure a competitive Canadian mortgage rate and benefit from a bursting bubble.

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