Over the last three weeks Iâ€™ve tried to explain in reasonable terms why real estate is overvalued in Canada, and will correct. That should happen concurrently with interest rates rising. There is no doubt both will occur.
I have also published a number of emails from people asking for my opinion on their own housebuying aspirations and their unique circumstances. Now I will make a few final points.
Most people, it seems, migrate to this blog because they are homeless, rather than students of the economy or investors looking to build wealth. By â€˜homeless,â€™ I mean they lust to own real estate (and usually rent nice digs) and were first attracted to me since I seemed to be an oracle foretelling a housing crash. Now some of them doubt my mystical powers (join my wife).
Hey, there are perfectly valid reasons for wanting to own a home, and the letters Iâ€™ve shared with you show how irresistible they can be. Many people equate real estate ownership with stability. They just wouldnâ€™t consider having a kid without buying a house. Others fear renting, thinking they might be forced to move in a few years (even though most homeowners now move every 3.5 years). Some are convinced rent is wasted cash flow, even though paying the interest on a mortgage is equal. And others just have an overwhelming need to nest, to have a place they can paint chartreuse or nail plywood butterflies on the garage.
Canâ€™t argue with that stuff. Itâ€™s in the genes.
But for those who buy because they believe itâ€™s a smart financial move, a good investment, a wise use of capital or who swear housing is an essentially undervalued asset retaining the potential for large capital gains, well, get over it.
Here is my message:
Thereâ€™s a rally going on with real estate at the moment, as there is on the TSX. In both instances, itâ€™s a bear market event. This is a rare opportunity to get out, while there are enough fools around, desperate to get in.
To reiterate a couple of key reasons why this is so:
- The current buoyant housing market is the artificial creation of central bankers who are pulling your strings. If interest rates were not suppressed, there would be a housing glut with few buyers and falling values. The policy makers took rates to the lowest point ever because they knew without an aphrodisiac, you would not get hot and bothered and expose your chequebook. It was crass and manipulative, but it obviously worked.
- So, with a home-buying binge with rising prices and multiple offers having been stimulated in the middle of a recession, nobody should be under the illusion it will last. Interest rates will be rising because of many factors, including a massive need for capital by governments now with bottomless deficits to finance. As countries compete for capital, the price of it goes up. Add to that the inflationary aspects of public spending, rising energy prices and a recovering global economy over the next few years, and rates will likely double.
- This dramatic increase in mortgage rates â€“ from, say, 4% to 8% – impacts house prices, since a home is worth what someone can afford to pay for it. Today, at 4%, a $500,000 home might be â€˜affordableâ€™ since $450,000 in financing costs $2,300 a month. But if mortgage rates rise to 8%, then $2,300 a month finances only $300,000 â€“ which suggests the market value of that home should be closer to $350,000.
This underscores a basic rule I have always held out as irrefutable: When the average family can no longer afford the average house, the market corrects.
There is no doubt interest rates will rise over the next few years, and substantially (this is worth reading). Buyers today have a far greater threat facing them than simply not being able to afford higher mortgage payments upon renewal. The real risk is declining valuations pushing them into negative equity and turning their emotional nests into wealth traps.
Finally, what about the argument that rising inflation â€“ also inevitable in years of recovery â€“ will lift real estate values as it did over the past 30 years?
Well, itâ€™s bogus. Three decades ago, house prices were advancing from a low point when affordability was exceptionally high. Today real estate in major cities is at, or near, its historic peak. More importantly, in the Seventies and Eighties, the largest group in the population, the Boomers, were having families and setting off a real estate boom. Today those Boomers are on the verge of historyâ€™s greatest property dump.
Donâ€™t know about you, but I see only one outcome. And it has claws.