The plunge to come

It’s Friday. A good day to hate on Kumail.

“I’m an avid reader of your blog and have been renting a condo and saving the difference for a number of years now,” he tells me. “My fiancé and I are looking to potentially buy a townhouse in the Leslieville area as prices continue to drop.”

Okay. Understandable for those who have been watching the market and wanting a house for years. The average detached in TO is $450,000 cheaper than it was in February – but still north of $1.6 million. So does it makes sense?

“We make $500k annual total income, with that continuing to rise over the next few years as I’m in tech and she’s in healthcare.  Do you see prices continuing to nose-dive throughout 2023? Would you recommend buying or renting over the next few months?”

So I asked for details. Turns out K is 33. The soon-to-be-Mrs K is 28. The goal is a semi or townhouse for about $1,300,000. Here are the current assets: $325,000 saved for a downpayment, $165,000 in liquid investments and cash, plus a cottage worth $425,000 financed with a $305,000 mortgage.

First, the net worth situation. Today these Mills have liquid wealth of $490k and real estate equity of $120k for a total of $610k with $305k in debt. If they buy in Toronto and stick to the budget they’ll have $165k in liquid assets and $445k in real estate equity for the same total of $610k. But debt would swell to $1,305,000. From 19% of their net worth, real estate would zoom to 73%. Debt would increase from 50% of NW to 214% – at a time when interest rates are rising and real estate falling.

Does this make sense? Even for house-lusty kiddos raking in a half million annually?

Here’s the latest on what comes next.

RBC’s new report is pure gloom. “The Bank of Canada’s rate hiking campaign since March has added hundreds of dollars to mortgage payments that come with a home purchase,” it says. “This, along with the jump in property values during the pandemic have made it more difficult than ever to become a homeowner in Canada… the impact of higher mortgage rates has yet to fully run its course.”

Source: RBC, Bloomberg

The bank finds average people need to spend 60% of their pre-tax income (even if they have a 25% down payment) to carry a house. That’s epic. But in Victoria the number hikes to 67%. In Toronto, 83%. In Van, 90%. In other words, it is utterly impossible.

“The spike in interest rates since March—the policy rate is up 300 basis points to date with another 75 basis points on the way by year-end in our opinion—is raising ownership costs in every corner of the country… It will likely take years to fully reversed the tremendous deterioration that took place since 2021.”

K and his mate are not average, of course. They make oodles. But real estate’s price decline has only really started, as the bank suggests. The bottom is a ways off – at least next spring.

And here’s the Parliamentary Budget Officer weighing in. His conclusion: we’re kinda screwed. To be affordable to the average family, he reports, the average house price should be $494,952. Not the current $777,500. So real estate nationally is 67% overpriced. Yikes.

Even CMHC, in the business of heroic house-humping, is dropping its estimate of future price moves. There’s another 15% ahead, it says, as well as a “protracted drop” in market activity as the CB piles two or three more rate hikes atop the 300 basis points already moved. “We’ve seen that inflation has been more persistent than we originally anticipated and the Bank of Canada is taking more aggressive action, so we’re in the process of revising our forecasts,” the agency says.

Finally, you know things are dire when Re/Max alters its mythical market projections. From a sustained price increase in its last report based on butterfly migration changes and TikTok  influencers, the floggers now admit things are going in the opposite direction. Valuations will plop.

So back to Kumail.

Big incomes, great jobs, moderate debt, growing liquid assets, real estate equity already held, plus youth. Why would they want to mess this up? Why take on a million in debt? Why thrust three-quarters of net worth into one asset class? Why buy now when the price decline may have only just started? Why not wait six months and get a whole house for the price of half of one? Or stay renting, eschew the rising cost of debt and have millions in liquid wealth in a decade or so?

Logic says take a pass, K. I will not enable you.

About the picture: “Figured you need some more dog content for the blog,” writes Rose. “This is our buddy Gus who turns 2 in October (who previously made an appearance on the blog). He’s full of life and reminds us to not sweat the small stuff. Thanks for the free content! Sorry to hear of your crazy interaction with that biker the other week, and also the aggressive emails you’ve been receiving.”

The performance

   By Guest Blogger Tatiana Enhorning

Why do we begin investing in the first place? Many of us want our money to work in some capacity. We want to build our wealth for future goals or, at the very least, not see our hard-earned cash to be depleted by inflation. We want it to grow, and we don’t want to lose it.

Those who have a natural propensity toward risk often find they can simply go online, read a few articles, get the timing right on a stock or two and earn good short-term returns. It can seem easy and exciting to see money grow by 10% in a day! But if you are making risky investments without a strategy for protection, it’s not investing… it’s just gambling.

Charging headlong into high risk/high return securities can have a large upside but also a huge downside. This is not a feasible long-term strategy. As Warren Buffet taught us: “the first rule of investing is don’t lose money”. In order to actually sustain the performance of your investments over seven years or more, you must weather the down markets. That’s a skill requiring both nerves of steel and some finesse.

Investing can be compared to many competitive sports where achieving the best performance not only requires power but also precision. For example, a basketball player must be careful how hard he shoots the ball to make a basket, not just bounce it off the backboard. In gymnastics, you earn marks by taking risk such as throwing a backflip and landing on a four inch wide balance beam. By going higher and harder, you can earn more marks. However, if you fall, you will lose even more. Risk versus reward, it’s a fine balance.

Once you have the experience to know exactly how much risk you can take and still hit your target, you win. More often than not, you will actually perform better overall if you sacrifice some height to ensure you don’t fall off track.

That is why protecting on the downside is key to the long-term overall performance we want. In fact, when asset management firms build products for financial professionals to use with institutional investors like large pension plans and plan sponsors, they know high returns are not the only consideration. They are investing people’s pension savings for retirement over decades, without the option of losing them. Their data analysis and experience makes it clear a fund’s “downside capture ratio” is just as important as growth in achieving the desired performance.

Knowing the ‘downside capture ratio’

The downside capture ratio is a measure of how much an asset or fund falls compared to a benchmark. If the fund goes down 100% as much as the benchmark, there’s no protection. If it only goes down 80% as much as the benchmark, your assets don’t have to recover as much in order to get back into the black. Good downside protection leads to good long-term performance.

To achieve this, asset managers choose high-quality stocks or bonds, and they ensure portfolios are well balanced and diversified. Year-to-date, we have all been tested by the worst market returns in several decades. But Turner Investments employs an institutional management style and the downside capture ratio of our portfolio has been  66.16% when compared to an analogous balanced portfolio and has been 60.70% compared to the S&P 500 index. Protection on the downside is further highlighted when we take that balanced portfolio compared to the S&P 500 over the last three major bear markets:

01/07/2009 – 03/09/2009 (Credit crisis) = 44.92% downside capture
02/19/2020 – 03/23/2020 (Covid hits)  = 79.11% downside capture
01/03/2022 – 06/16/2022 (Rates surge) = 67.70% downside capture

For people who have not seen the natural patterns of financial markets repeating over long periods of time, it has been easy to fall into the trap of myopic loss aversion, getting emotionally attached to short-term market fluctuations, then wanting to take less risk. It’s normal, but can lead to common mistakes like avoiding all risk, or worse, locking in losses by cashing out at the bottom.

It’s important to remember the big picture, why you started investing. If you have a strategy that incorporates downside protection, you just have to remain steadfast to your logical plan when markets get tough instead of opting out of all risk and all gains, or succumbing to the adrenaline rush of gambling on the markets. Like an athlete going for gold, having a clear vision of what you want to achieve long-term, focusing on protection to achieve performance, and maintaining a calm, unwavering mind – that’s how you win.

One could say… it’s all about balance.

Tatiana Enhorning is a Financial Advisor with Turner Investments. She builds and maintains portfolios for clients across Canada, and has been in the business as an asset manager for more than a decade.