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What housing crisis? Many homeowners would be spared in major correction

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Ross Andrews, Special to Financial Post | 13/05/09 | Last Updated: 13/05/09 10:50 AM ET

There is a housing market correction in the making and it has the banks a little worried — but homeowners even more so. Get ready for a slew of “Told ya so” commentaries from anyone who has predicted a crash over the past decade. Cry about something long enough and eventually it’ll come true. But let’s take a step back and think about the situation.

Signs of a Canadian housing downturn are everywhere

Let’s not argue over whether Canada is the proud owner of a pretty pink housing balloon or a black bubble because either way, they both can pop.
If, say, you bought a house in Toronto 10 years ago, there’s a good chance your property has almost doubled in value, especially if it was considered “affordable” back then. A $275,000 house in 2003 is probably getting $500,000 today, maybe more in a desirable area. That’s a $225,000 gain on paper. Further, let’s suppose you weren’t foolish enough to take a 40-year amortization — since banned for insured mortgages by the government — and had a down payment of at least 10%.

If that’s the case, don’t worry about a big correction unless you either a) have to sell because you’re moving away, or b) were planning to use your house as a big chunk of your retirement fund, both of which depend on someone buying your house in what would be a depressed market.

Here’s why. If housing prices were to drop by 44%, or enough to cause securities linked to Canadian mortgages to lose the highest ratings assigned by Moody’s Investors Service — in other words, if a massive shock to the economy were to occur — that $275,000 home would be worth $280,000 and you would probably still owe more than $50,000. You’d be in the hole, never mind interest paid and inflation.


But you have to live somewhere and while rent is generally a bit cheaper than paying off a house, it’s not that much different because you’re often paying someone else’s mortgage. Landlords generally account for maintenance and property taxes, too.

A more likely scenario is that Canadian home prices are overvalued by about 20%. That view, espoused by Fitch Ratings, doesn’t sound too bad given the rapid rise of prices over the past decade. What you have with a mortgage is an enforced savings plan that, at worst, is still better than putting money in the bank or a GIC. But before you get full of yourself for thinking how smart you are, take a look at your other investments. You do have some, right? No? Uh-oh.

“People say they want to pay off their home fast because God forbid anything happens to the market,” says Bob Stammers, director of investor education at CFA Institute. “But you have to remember that if you’re putting money into other assets and find yourself in that situation — hopefully no one does — you could always divest yourself of your other assets to pay off your home.”

Unless you paid cash for your home, the amount of risk and sensitivity you have to the market is going to be a function of how much debt you have and your ability to pay it back. Every situation is different, but Stammers recommends that a home comprise no more than 30% to 50% of an investor’s portfolio.

A portfolio too heavily weighted in one asset — any asset — is more at risk than a properly diversified one. Would you sink 50% of your investments into BlackBerry stock? Probably not. How about India? Again, doubtful. “We don’t tell people they shouldn’t be real estate investors, but we do tell them it should be part of a balanced portfolio,” Stammers says.

It can be hard to not own more house than you can realistically afford today and, more importantly, tomorrow. Rates are rock bottom and Canadian banks have come up with a variety of ways, from the 40-year amortizations to cash-back mortgages, to allow just about anyone to own a home. True, they were never as greedy as the banks in the U.S., which handed out NINJA (no income, job or asset) loans that came around to bite the industry and essentially caused the 2007-2008 financial meltdown. But people, from Dartmouth to Delhi, seem hard-wired to own property.

“Traditionally, land was where all the big fortunes were made so I think it’s ingrained in people, this idea of owning land and owning real estate,” Stammers says. “But as the markets become more complex and more sensitive to economic shock, it doesn’t hold as it did before.”

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