Back in May we wrote a piece on the housing market during COVID-19. In that article we looked at how the housing market was strong going into 2020, but how between February and April, things deteriorated quite rapidly. We also looked at the possibility of the average price of a house continuing to decline.
Well now 3 months after we wrote that piece, the housing market has done more than just recoup its losses. Although we cannot give a ‘one-size-fits-all’ answer to whether now is a good time to buy a house, we wanted to present some important things to take into consideration.
Below we want to look at the current developments in the Canadian housing market, and then look at three reasons why we may see a decline in the housing market.
Housing Thus Far in 2020
After getting hit quite hard earlier in 2020, the housing market has made quite the astounding rebound.
Whether this surge was warranted is another question. One that we won’t really be touching on.
The month of July, 2020, was a historic month in the housing market for Canada. There were more homes sold in July than any other month in the past 40 years.
Every notable statistic when it comes to housing was drastically up in July according to CREA. Home sales (up 26% month-over-month), actual activity (up 30.5% year-over-year), new listings (up 7.6% from June to July), etc. Even housing starts were up significantly at 15.8% from June.
Although the housing market may have rebounded and surpassed pre-COVID levels, it may not stay that way. Below are four potential reason why we might see the housing market decline in the coming years.
The first reason why we may see the housing market decline is income security. A lot of people have had seen their income cut, either partially or completely.
Due to this lack of income, at the time of writing Canada.ca says that $80,473,000,000 has been paid out just in CERB. So obviously we know that income security in the last 6 months has been lacking (unless people have been taking advantage of CERB… but that would never happen).
So why is income security important when it comes to the housing market?
Well there are several reasons. The first of which is, without income security making mortgage payments becomes extremely difficult. As more people are unable to make their monthly mortgage payments, more foreclosures and forced sales will happen.
The second reason being, that if you cannot show a source of income, being approved for a mortgage becomes next to impossible. Two of the main calculations that are done when applying for a mortgage are the Gross Debt Service Ratio (GDS), and Total Debt Service Ratio (TDS). Both of which take gross income into account. A lower gross income means that you will only be approved for a lesser mortgage.
At this point you may believe that your income is 100% secure. We truly hope that is the case. However, after this pandemic a lot of peoples perspectives will have changed. What we put our time, money, and effort into will shift.
This pandemic has caused people to realize what they truly value. This might mean less is being spent on ‘things’ in general. People may now be just as happy staying at home spending time with friends and family, while saving more money.
This shift in perspective could then trickle down to the job market. Some of those jobs that were cut due to the pandemic, might be gone permanently. Many businesses have been forced to downsize and/or close up shop permanently. This brings us to the next point.
Increased Carrying Costs
With potentially less people in the work force, and less competition in some industries, prices for services could increase. The cost to hire your local carpenter, electrician, plumber, etc. could increase substantially.
Lets assume demand for their services stays the same. The same amount of houses still need repairs each year and the same amount of houses are being built. However, now supply of that service is restricted. Instead of 10 people doing each of the services above, now there is only 6.
Supply and demand economics would say that if demand is higher than supply, that the price of the supply will increase.
Another thing to consider with carrying costs is property tax. A lot of towns, cities, and municipalities have been hit hard. These enities normally make money in one of the following ways: property taxes, user fees, and transfer from other levels of government.
Now if you don’t understand the concept of inflation, you may think the best course of action would be for the federal government to print more money and give it to the towns, cities, and municipalities. However, there are some considerable political, economic, and social consequences of money printing, making it a less than desirable option.
So, assuming the federal government/BoC won’t do that, it means that property taxes and user fees could increase. This could have a significant impact on the carrying cost of owning a house.
Tightening Mortgage Expectations
As the housing bubble continues to inflate, it wouldn’t be unheard of for lenders to tighten their mortgage expectations. As the bubble inflates, people who are currently at the bottom end of qualifying will be more and more likely to default.
These tightening expectations could come in a variety of ways. Lenders could require larger down-payments. They could lower the acceptable gross debt service ratio and total debt service ratio.
Whichever route lenders take to tighten mortgage expectations, the results could be unfavorable for the housing market. As less people qualify for mortgages, it means there will be less potential buyers. With less buyers on the market, houses may stay on the market longer and/or sell for a lower price.
Potential Forced Downsizing
Although this isn’t a concern yet, we could see this happen in the future. The forced downsizing would not necessarily be due to pressures from the lender. Rather, it would be a somewhat last resort by homeowners.
The following is based on the most recent data we could find on statscan going back to 2016. According to that data the median Canadian principal residence was $349,000. On that principal residence the median Canadian had a mortgage of $180,000. This means they had equity of $169,000 ($349,000 – $180,000).
According to the same data, the median Canadian had a net worth of $295,100. That means that home equity accounted for roughly 57.3% of the median Canadians net worth.
If we look at individuals 65 years and older the numbers are different. They have a net worth of $517,100. Of which, $200,000 is home equity. That accounts for 38.7% of their net worth.
The housing market has risen significantly since 2016. The average house in Canada in 2016 cost $490,495. The average house price in 2020 is forecasted at $531,000.
As the housing market continues to inflate, more of Canadians net worth is tied up in real estate. This may not sound terrible on the surface but in the current landscape, it could have some adverse future consequences.
Why Having Net Worth Tied Up in Real Estate Could be Bad
There are a couple key reasons having more net worth tied up in real estate could be bad; potential lower investment returns, and pension plan troubles.
In our current low interest rate market, generating returns can be difficult. With such an inflated stock market, generating return in even the 6% range could become more difficult in the years ahead.
In Addition, a lot of people rely on employer provided pension plans for their retirement income. However, a lot of these pension plans are in danger. With more and more baby boomers and now Gen X’ers retiring, these pension funds are running into under funding issues. They are having to pay out more retirement benefits than they are generating from investment rates of return and working participants contributing.
The lower returns are a big concern. If the pension plans cannot generate the target investment return, some corporations will be liable to pay “top-ups” to pension plans. This is dependent on the type of pension plan they have established but is generally an expense they do not budget for. Having to pay additional money into these pension plans just exacerbates the issue and is only a temporary measure.
So, if personal savings and company pension plans are struggling to generate their needed returns, we could see the older generation drawing down their savings faster than anticipated. Once those accounts are depleted, or when people realize their savings won’t last as long as they thought, they will likely turn to their home equity.
With so much of their net worth tied up in the homes, a lot of people may look to sell and downsize in order to continue funding their retirement. This could put downward pressure on home prices.
In the end, there is more that should go into buy a house than just whether or not you can make the payments. Is now a good time to buy a home? It might be. However, this is dependent on your individual situation.
What are you motives for buying a house? Can you afford the house (there is a difference between being able to pay for something and being able to afford something)? What is your time horizon? Are you looking at the home as an investment, or a place to live? etc.
Buying a home is most likely your biggest financial decision. Do not rush into it. Lastly, just because house prices have risen throughout history doesn’t guarantee they will continue to do so. Be diligent and be prudent. Crunch some numbers and sit down with a professional. Make sure you are prepared and can sustain choppy waters if that is what lies ahead.
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Disclaimer: This Forbes Wealth Blog is for informational purposes only and does not constitute financial, legal, or tax advice of any kind. Please consult your legal, accounting, tax, investment, banking, and life insurance professionals to get precise advice relating to your particular situation before acting upon any strategy