It's official: real estate prices are going up. Actually, we like to shy away from predictions like that because we can't be 100% certain. We prefer to educate ourselves as best as possible and let everyone draw their own conclusions. Unless there is a massive shift in government spending and policy, owning assets like real estate becomes absolutely essential in any prudent financial plan.
Why?
Because government spending levels are just going up, and there is much more to come. All three major parties ran on platforms in the last election that involved borrowing more money to put into the system, with no talk of the long-term implications of these policies. Here are the money supply numbers in Canada compared to the average selling price on the Toronto Real Estate Board.
The M2 Money Supply in Canada includes physical currency, money held in checking accounts, and easily convertible deposits. This means savings accounts, money market funds, term deposits, and anything else that can be converted to cash quickly. It is the accepted metric for evaluating the supply of capital.
M2 Money Supply in Canada
They match almost exactly. This is almost a 50-year trend. As you can see, in the 1990s, there was a pullback in housing prices that matches a decline in the M2 money supply over the same time period. We just elected a government that has increased our M2 number faster than any other one in history. They ran on a platform that includes more spending, and we believe that they will continue this trend. Without savings to pay for it, the money supply has to go up as they borrow more money into existence. This is the basis of quantitative easing, which is a tool the government is using to get us through the recent shutdowns due to Covid-19.
Housing Supply
“There were 2.1 months of inventory on a national basis at the end of September 2021, down slightly from 2.2 months in August and 2.3 months in June and July. This is extremely low and indicative of a strong seller’s market at the national level and in most local markets. The long-term average for this measure is more than 5 months.” (Canadian Real Estate Association).
There just isn’t enough inventory for demand on the market. Of course, this is a national number, and real estate markets are much more local. We are sharing this to highlight why prices are up in almost every major market in the country.
Now look at this headline from the Canadian Government:
“Following the tabling of the 2020 Annual Report to Parliament on Immigration, Immigration, Refugees and Citizenship Canada (IRCC) is pleased to release details on the Government of Canada’s Immigration Levels Plan for 2021-2023. Canada aims to welcome 401,000 new permanent residents in 2021, 411,000 in 2022, and 421,000 in 2023.” (https://www.canada.ca/en/immigration-refugees-citizenship/news/notices/supplementary-immigration-levels-2021-2023.html)
Am I reading this right? We have a historic housing supply issue, and the government plans to bring in an additional 1,233,000 people over the next 3 years. That's like taking Calgary and dumping it into the Canadian housing market in 3 years. While many municipalities and developers are working together to create housing, we know that this is a long, drawn-out process that takes years and even decades to complete.
Here is a 50-year graph of new housing starts in Canada:
Housing starts in Canada fell 4.4 percent over a month earlier to 251,151 units in September 2021, marking the fourth straight month of decrease and falling below market expectations of 255,000 units, according to the Canada Mortgage and Housing Corporation (CMHC). It was the lowest reading since December 2020. Urban starts declined by 4.5 percent, driven by a 4 percent decrease in multiple urban starts to 165,861 units, while single-detached urban starts decreased by 5.9 percent to 57,194 units. Rural starts were estimated at a seasonally adjusted annual rate of 28,096 units.
Dispelling Some Myths
With the high price of real estate in the country, I continue to see many articles published by economists and policymakers in Canada bemoaning the prices and warning Canadians that we are in a bubble. The argument goes that prices are out of line with historic measures of income-to-price ratio (which they are), price-to-rent ratio, household debt-to-GDP ratio, and the historic 10-year compounded annual growth rate. Let's break this down for a minute.
Price-To-Income Ratio
I won't dive into the stats here. I think we are all aware that our houses have risen in price faster than our incomes have grown, making a new home purchase for a first-time buyer more and more unaffordable. The risk here, of course, is if the interest rates rise on mortgage renewals, people that have bought a house out of their price range may have to renew at a higher rate, making their new mortgage unaffordable for them. This is certainly a risk in the higher-end homes within the GTA and surrounding areas. I don't see this affecting the real estate investment market. If someone can no longer afford their home on renewal, it leaves them with 2 options. Either downsize to a smaller, cheaper home (driving up the starter home market) or get into the rental market. Both of these scenarios bode well for investors that are buying starter homes and multiplexes today. All we have to do is look at what happened south of the border during the 2008 financial crisis. Prices dropped dramatically, yes. The rental market stayed fairly robust, however, and 10 years later, those that were able to weather the storm have made out very well.
Price-To-Rent Ratio
Yes, it is expensive to own a house. Yes, the relative affordability of owning vs. renting is getting tighter in city centers. This metric completely ignores the fact that outside of city centers such as in Niagara, it is still quite possible to purchase a home with a mortgage, and the market rents are able to cover not only your mortgage payments but also taxes and insurance with money left over. Rents have actually risen in areas like this at the same rate as home prices as more and more people are pushed out of the GTA.
Household Debt to GDP
The argument here is that as debt servicing goes up and household budgets are tighter upon renewal, there is less money to spend in the economy, creating a contraction in the overall economy. If the economy takes a hit, so do house prices. This is definitely a concern, however, I would argue that if we know anything about governments (and Covid-19 proves this), they are not afraid to spend their way out of an economic downturn. No one wants to be at the helm when the ship starts to sink. Hence the mantra over the last 2 years: Don't fight the Fed. When the government prints money and makes it more available, scarce assets like real estate go up in value. Again, even if the economy does take a turn and people are forced from their homes, it only drives up demand in the rental market.
10-Year Compounded Annual Growth Rate
The home prices have definitely risen at a rate much higher than the average CAGR. No argument. However, so has government spending. Inflation is also higher than the average. Lumber tripled at one point. Gas, groceries, rent, dairy, meat, homes, cars, lumber and building materials, furniture, and nearly everything else you can imagine has gone up in value. There are a few exceptions, such as technology that trends cheaper with time, but on the whole, it is much more expensive to live in Canada than it was. I don't think looking at ordinary historic averages is going to help in an extraordinary time.
Conclusion
Are we in a bubble? Real estate markets are local, not national; it's hard to generalize. Some areas may be closer to bubble territory than others. Let’s start first by defining what a bubble is, whether it’s in real estate, tech, or cryptocurrency. A bubble is an asset that is appreciating quickly with no underlying fundamentals, is speculative in nature, and therefore investors have an increased risk of loss when the market price corrects downward toward a more fundamentally strong base.
Let’s recap some of the fundamentals underpinning the Canadian real estate market. From the above stats, we can see that we have an ever-increasing supply of money being dumped into the system here in Canada. Are asset prices going up or is the value of our dollar going down? We would wager that it is some of both; however, the best hedge against inflation is a hard asset. A devaluing dollar + low housing supply + lofty immigration targets/exploding populations + low-interest rates = higher real estate prices.
We are well aware that past performance guarantees nothing in the future. However, unless there is a major shift in bank lending, supply, demand, or immigration, this makes a pretty strong case for higher real estate prices. We are in a unique location here in the Niagara Region. We are seeing an influx of residents and investors from the GTA as they get pushed to cheaper markets further away from the city centers. In fact, the real estate market in the Niagara Region has appreciated at approximately 40% year over year in comparison with approximately 25% in the GTA.
One of the potential challenges ahead for the housing market is interest rates. Due to low rates, the average consumer can afford more house at a higher price and still keep their monthly payments at an affordable number. If we see significant rate increases, this can put downward pressure on the housing market. However, higher interest rates will make housing even more unaffordable for first-time homebuyers and those that are looking to upgrade, which was an election issue just a few months ago. Higher interest rates also mean a ballooning deficit on the Canadian Government balance sheet.
We do know one thing for certain. Rates CANNOT rise higher than inflation. If rates went above the rate of inflation, it would be a death sentence for the economy. And because of this, in our opinion, it makes sense to continue to hold and buy hard assets.
Think of it this way...
Once you subtract inflation from whatever the rates are...you are likely getting a negative number. When that happens hard assets tend to go up in price, often aggressively, because the money supply is expanding faster than hard assets are.
Another risk is some sort of credit contagion or an interruption in lending. This was a major factor in the last US market downturn and it could cause problems here as well. That is why when we purchase properties, we go in with the mindset to own them for 10 to 20 years. We feel if we plan this way, then we can make it through any market downturns. We know things can change very quickly, and we plan to buy good assets that have cash flow to make it through any inevitable ups and downs.
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Jonathan Beam
Real Estate Investor and Entrepreneur
Jonathan Beam is a real estate investor in the Niagara region who is passionate about helping you achieve financial freedom through real estate. He works with new and experienced investors to formulate a plan that fits your specific situation and provides market guidance and consultation on the best places and strategies to pursue within the Niagara Region. Book a free, half hour no obligation consultation to see how he can help you to achieve your goals. His travels are available at www.realestateandrepeat.com
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