The housing market in Canada has been compared to the stock market of our southern neighbors. Canadians have a large portion of their wealth tied up in housing. Much like Americans have so much of their wealth tied up in stocks. If either of the two markets were to hit an extreme rough period, it could have detrimental effects on the respective economies. This is why, again and again, we see continual federal bail outs, particularly in the states.
A CHMC release from January 2021, gained significant media attention. In the release, they presented the stark possibility that housing prices could be slashed dramatically. Below we will look at the release more in-depth and what that could mean for Canadians.
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CMHC Stress Testing
In a report entitle Coordinated Government Action Key in Withstanding Pandemic Scenarios, CHMC did a stress test of its own capital and liquidity. The stress test included five scenarios differing in severity and likelihood. The 5 scenarios that were tested include the following which is listed by increasing plausibility and the economic effect:
- Baseline
- U-Shaped Recovery (Moderate)
- W-Shaped Recovery with Government Support (Severe)
- W-Shaped Recovery with Government Support + Cyber-Attack (Severe)
- W-Shaped Recovery without Government Support (Very Severe)
According to the tests that they ran, CMHC would remain solvent and well-capitalized in all scenarios. That is except for the most severe one. Under all scenarios, CHMC maintains sufficient liquidity to meet its insurance and Timely Payment Guarantee (TPG) obligations.
Based on their provided chart, which can be found in the link above and under sources, losses for CMHC will range between $3.61 Billion and $15.30 Billion. These losses and the risks associated with them will differ based on the borrower’s geographical region, employment, and type of dwelling.
According to CMHC, loans originating from oil-producing provinces show a higher risk. Likewise, borrowers employed in the service sector produce the highest simulated loss rates. On the other hand, tech, education, and government sectors are expected to perform better. Lastly, although condominiums only make up 10% of housing, they account for almost 70% of loans currently at risk of being underwater (mostly driven by condo price declines in Calgary and Edmonton).
Near the beginning of the report, CHMC explicitly says that the scenarios are for testing purposes only and are not predictions or forecasts. however, there was one number from the report that garnered a lot more media attention than everything mentioned thus far. That number was the -47.9% change in housing prices under the most severe scenario. Although it is unlikely to come to pass, it is still worth thinking about.
Effect of Severe Housing Price Declines
A lot of people have a significant portion of their net worth tied up in their principal residence. With many believing that when the time comes, they will downsize, and use the proceeds to support their retirement. On the surface that doesn’t sound like a bad plan. How realistic is it though?
Eventually your house becomes your home, that is where your memories are, where gatherings are held, and where you feel comfortable. We become attached to our dwelling. We also hit a point where moving isn’t as easy. Maybe a couple is forced to downsize in their 80’s to maintain their retirement lifestyle. How are they going to manage all of the physical work that goes a long with that? Especially in todays world where families are no longer as centralized as they once were.
Let’s assume you are able to plan it out perfectly that when you retire you have the perfect amount of money. So much so that your net worth hits $0 on the day you die. When you start retirement 50% of everything you’re going to need in retirement is in investments and the other 50% is in your house. What would you be more likely to use up first? Sell the house and use the proceeds? Or, cash in some investments? My guess is investments, and the longer you would wait to downsize the house the harder the move becomes.
Canadian Net Worth in Housing
According to Statscan, the median net worth of Canadian families is $329,900. According to the same survey, the median value for principal residences was $400,000. The median mortgage on those principal residences was $180,000. That means equity in the house was about $220,000.
With some simple math we can see that the median Canadian household has a net worth, not including principal residence, of $109,000. This means the median Canadian household has two-thirds of their net worth tied up in their principal residence.
Well, assuming that $329,000 is enough to retire on, what happens if your home value is cut in half? Your house is now valued at $200,000, and your equity in the house drops to $20,000 because you still have that mortgage. Your net worth is now only $129,000 if you sold your house. $129,000 won’t last very long if you’re drawing a monthly income from that lump of savings.
In fact assuming you need to draw down $2k a month that will only last about 6 years assuming a 6% net RoR.
Conclusion
Although it is always nice when asset prices increase, it is important to make sure you are diversified. As shown above, many Canadian families are over concentrated in real estate. The median family has 66% of the net worth tied up in their principle residence. As we have demonstrated, although downsizing may sound like a good retirement plan, it may not be practical in the future.
If you find that you are overconcentrated in real estate, it is not to late. Hedging your risks with proper diversification is always a possibility. Call or sit down with your financial advisor to review your retirement plan. It may not be as secure as you believe it to be.
For more on housing check out Using a TFSA vs. Buying a Rental Property.
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Sources:
https://www150.statcan.gc.ca/n1/daily-quotidien/201222/dq201222b-eng.htm
