The Canadian housing market continues to defy gravity! 🙂 According to CREA the average home price in May increased to $416,584, a 7.1% jump from a year ago. The number of homes sold also increased by 5.9% month over month, which is the largest gain in several years.
A lot of people feel concerned that this kind of growth is unsustainable. They question how prices can increase so much without personal incomes growing at the same pace. Many have concluded that we are surely headed for a correction soon.
I hope I can explain what’s going on, and why it would be perfectly normal for home prices to move even higher.
As an investor I know from experience that personal income has very little to do with purchasing power or prices. For example I spent over $200,000 on stuff in 2013 (mostly financial assets) even though my take home income last year was less than $50,000. Living in a debt based economy means we have the privilege to borrow money from other people so we may buy things even if we don’t have the cash 🙂
Local incomes also don’t account for the massive amounts of foreign money that gets pumped into the Canadian housing market each year. But what really affects the price of homes is the cost of financing. Over the last year mortgage rates went down in this country. A 5 year fixed rate term is under 3% now. Cheaper financing options means people can buy more expensive homes.
If the Bank of Canada lowers its Key rate by 1%, bond yields would fall to almost nothing, and mortgage rates would be even lower than today. You could probably get a $300,000 mortgage for 2%, which would cost a new home buyer just $6,000 a year in interest to live there. That’s cheaper than renting a comparable property! On the other hand if the Key rate increases by 1%, mortgage rates will also climb, and many people wouldn’t be able to afford a $300,000 home anymore so home prices would drop across the board. If rates don’t move at all, home prices should simply increase at roughly the pace of economic growth, which is about 2% a year.
We have to also consider the lack of alternatives. Let’s think outside the box for a second and look around the world.
- According to the Case Shiller home price index, U.S. real estate values are 12% higher today than a year ago.
- Prices in the United Kingdom in March are up 8.0% from last year.
- According to AFR, Australian house prices are up 10.6% year over year.
So all things considered, a 7.1% increase in Canada seems pretty tame. Not to mention, both Canadian and U.S. stock markets are at an all time high. And our bond markets are also really expensive right now. 
If I only had $15,000 today and owned no other assets, I would go buy a $300,000 condo in Vancouver right away.
Some people might think I’ve completely lost my marbles. $300,000 sounds too pricey for a condo. But from a larger perspective it’s really not 😐
Consider that $150,000 was once considered a lot of money in 1989. That was the average price of a Canadian house at the time. If someone bought a $150,000 house back then, with a $15,000 down payment and a 25 year mortgage, then that mortgage would be completely paid off by now, and the home would be worth $416,584. That’s a bloody good return on the original $15,000 investment 😀 Not to mention it’s all tax free.
Adjusted for inflation (CPI) $150,000 in 1989 would be about $250,000 in 2014 dollars. Since the average home today is worth more than $400,000 it’s evident that real estate doesn’t just hold its value over time, but it also provides real returns. I bet 25 years from now people will look back and think, wow only $400,000? Canadian housing was so affordable back in 2014 😀
Home ownership isn’t for everyone. Some people are better off renting. But just remember, successful money managers tend to think big, global, and long term 🙂
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Random Useless Fact:
In 1938, TIME Magazine named Adolf Hitler as the Person of the Year
Awesome post Liquid, I luckily bought a house last month lower than the average price. I know 1300 square feet is very small, but it is all we need now.
I like the last sentence “in 25 years from now people will look back and think housing was so affordable in 2014” :D. It is absolutely true.
Cheers,
1300 sq ft is a good size for a young couple 🙂 Getting into the real estate market early can have many benefits down the road. Since I already have a condo today it will be easy to upgrade to a bigger home in the future when I start living with someone else. Trying to save up a downpayment for a big house from scratch, without a starter home as leverage, is much harder.
If you don’t consider inflation, the return is less than 4.5% per annum, assuming you pay cash for the 150k house in year 1. However, taking the cost of finance (interests of mortgage), maintenance fee. property tax, insurance and the precious time, the return of buying the property in your example is way less than 4.5% per annum, which is no better than investing in stock market or even a GIC.
Great point 🙂 Which is why I never paid more than 15% down payment on any of my 3 real estate investments in the past. Using other people’s money to invest can multiply our returns to something much higher than 4.5%. Of course I would consider buying a property with 100% cash if mortgage rates were 20% lol. It all depends. Leverage can totally backfire and land me in negative equity territory 🙁 But I don’t mind the added risk because YOLO 😀
Home ownership is not for all, as there are lots of extras to ones lifestyle that need to be included – maintenance, grass cutting, taxes, clutter, gadgets, etc… For condos there are additional fees which need to be understood too. All that said, when we had our home built 15yrs ago, it cost $170K. We have added a few things, a deck, finished basement, shed, etc… all told about an additional 30K or so. Up coming maintenance will be for a NG furnace, roof and some exterior work, so another say 20K in updates. So that makes about 220K input. 2 neighbours homes recently sold for 390K and 410K, with one currently up at 425K… if I assume mine is somewhere in there, say 420K it makes us a return of 200K – any selling expenses (?5% or 20K), mortgage costs (10K – yes we paid the house off quickly, so incurred low interest cost)… that brings the house to having doubled our investment in 15years (rule of 72), or a 4.8% annual return… if I look to my investing history in Cdn stocks/mutual funds we have returned an average 8% over the same 15yr period, minus of course taxes… Read more »
As long as we live within our means and invest our savings we should all do well. It’s a simple concept that led you to retire at age 40, and many working people today can also do the same if they follow the same guidelines 🙂 I like to start off with a balanced portfolio of stocks and real estate and then dive further into more specialized areas once I become more comfortable as an investor.
Great time to lock in a low rate mortgage as its cheap money out there right now. Not sure about buying a condo tho. I have purchased many condos in vancouver and the costs with them is enormous. Huge spike up in maintenance fees and high property taxes. If I were to buy another condo in Vancouver I would look for an older 70,80s concrete building along a major transit line. The older buildings are of better quality and mostly concrete. They often have larger floor plans at a cheaper per sqft than newer ones. Then put your savings toward renos and bring the unit up to date. But its a tough call really with everything being so damn expensive.
That’s true. I wouldn’t want to buy any of the newer buildings with lots of windows. Glass maintenance can be a money drain over the long run. One of these days I’ll have to move into a bigger place. It’s hard to find 3 bedroom condos so I’ll most likely move into a duplex or detached home. Then I won’t have to pay condo fees anymore 🙂
Home ownership has many hidden costs too that people often underestimate. There is no doubt real estate is a great way to diversity your funds and assets. After all, most of us here are heavy on the dividend stocks. The thing about real estate its that it’s impossible to judge where things will be as individual markets vary as much as different stocks do whether looking at countries, cities or even individual neighborhoods. Real estate varies widely.
Agreed. Now I know why people say real estate is all about the local area. Prices and desirability can change a lot based on different neighborhoods and municipalities. National real estate studies aren’t as useful as they seem.
Investing in real estate can be a tricky business. The better you are at guessing the future patterns the better off you are. However, I think those who invest in it should be level headed enough to recognize that the future may not be precisely like the past, which could result in some serious losses. It can also result in surprise bonuses, but its good for those who want to invest to be aware of those risks.
Yup, a roof leak or a pipe burst can be a real financial blow to a homeowner. It’s important to under all the risks and consider buying insurance to protect oneself :0)
Hey Liquid, great post. I agree that when owning / investing in real estate we need to think about its long term potential (which has been very good over time) rather than short term price movements. The availability of cheap money with mortgage interest rates at historic lows has surely fueled the housing boom, but at the same time it would be interesting to see some data about the housing market relative to the stock and bond market valuations (which are also hitting new highs and are getting quite expensive).
Another high today lol. Stocks seem to be quite expensive indeed. I wonder how long this can keep going before a meaningful correction. I would like to see some data comparing stocks and real estate returns as well. Purely looking at asset appreciation alone doesn’t give a good representation of real life benefits because most people use a lot of leverage to own homes which can multiply their actual returns (or losses for some unlucky people.) I think there are also intangible benefits like the freedom to alter your own living space, as well as headaches like scrambling to replace a broken hot water tank, that you don’t face with stocks 🙂
Liquid, interest rates do not correlate very well with home prices. Here is a good article with Shiller’s data going back to 1890 which proves the point.
http://www.theatlantic.com/business/archive/2011/07/how-rising-interest-rates-affect-home-prices/241504/
Thanks for the article Michael 🙂 Looks like other factors in the economy can affect the price of homes more than interest rates.