By Steve Lowrie, Lowrie Financial
Special to the Financial Independence Hub
If you found yourself on the high seas, and the captain and crew were battening down the hatches, what would you do? Depending on how fast they were scrambling, you might at least make sure your life preserver was within reach.
If the Canadian real estate market were an ocean liner, recent government words and deeds have sent some pretty solid warning shots across the bow – especially for properties in the Greater Toronto and Vancouver regions. Real estate investors who may have forgotten the essential rules of self-preservation would be wise to consider the following:
In a June announcement, Bank of Canada Governor Stephen Poloz warned: “The pace of house price increases in Toronto, and especially Vancouver, is unlikely to be sustained, given the underlying fundamentals.”
Several provincial governments have been looking for ways to manage their real estate markets. For example, this July Globe and Mail article noted that British Columbia was trying to “cool the Vancouver market” by adding a 15 per cent transfer tax on property purchases made by international buyers.
The same Globe and Mail piece reported: “[T]he Office of the Superintendent of Financial Services said it would require lenders to stress-test their mortgage portfolios to ensure they could withstand a drop in home prices of 50 per cent in Vancouver and 40 per cent in Toronto. That’s half the value of your home that might perform a disappearing act.
And yet I am seeing “past” performance-chasing behaviours more and more frequently these days with real estate. These behaviours include; selling a diversified investment portfolio and piling everything into real estate, buying rental properties with no previous real estate or property management experience, buying condos in pre-construction that they don’t need because they can always “flip” it at a higher price before it closes, loading up on private and illiquid direct real estate funds … the list is endless.
I’m not predicting the timing, degree or even the inevitability of a real estate downturn. But it is very important to remember that returns of all asset classes work in cycles. Just because a certain asset class has delivered outsized returns for a long period of time doesn’t mean that the laws of “financial gravity” are somehow broken. Putting this another way, behaving as if real estate ventures will deliver magical returns forever is not only abandoning your proverbial life preserver, it’s like cutting up your lifeboat for firewood. Did people learn nothing from the last real estate bubble?
Putting real estate investing into perspective
So, if the magic is gone or if the outsized past returns are unlikely to continue – which could be sooner or later – should you jettison your real estate holdings entirely? That’s not what I’m suggesting either. A modest allocation to publicly trade real estate (REITs) can help reduce the overall volatility in your portfolio, since it has a tendency to “zig” when stocks and other assets are “zagging.” Instead, as I’ve covered in this related Q&A on real estate investing, you can apply most of the same essential investment principles, whether it’s real estate or any other asset class.
Avoid treating your own home as a real estate investment
By the way, if your home happens to appreciate over the years, that’s great. But don’t forget that its highest purpose is to provide a dependable roof over your head. While your home equity can serve as a potential rainy-day financial planning resource, it’s generally best thought of as a consumable expense rather than a reliable source of investment returns.
Also, don’t assume that you’ll reap a home-sale windfall when you’re older. I’ve seen many families expect to downsize their home in retirement and recoup some of their equity. From my observations, most retirees may change the kind of home they own, but their new living arrangements rarely represents a financial downsizing. Unless a family sells two properties to move into one, it more typically ends up being a lateral move, cost-wise.
Reason over magic
Whether it’s your home, a “sure thing” property venture, or an investment in the real estate market, our advice is to apply evidence-based reasoning and big-picture financial planning instead of depending on magic or hype to achieve your goals.
Steve Lowrie holds the CFA designation and has over 20 years of experience dealing with individual investors. Before creating Lowrie Financial in 2009, he worked at various Bay Street brokerage firms both as an advisor and in management. “I help investors ignore the Wall and Bay Street hype and hysteria, and focus on what’s best for themselves.” This blog appeared originally appeared on his site on August 16th and is republished here with permission.