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Fundamentals of Surging Real Estate Prices in Canada

Updated: Feb 15


We often overlook the foundations of real estate pricing, as we head into what seems like a never ending bullish market in Canada. While I am definitely not a real estate guru, I can still confidently say that there are many things wrong with this "tone" towards one of the most biased market existent today. Despite the challenges that the market will face in the years to come, many still believe that real estate assets will remain resilient and continue to perform compared to other alternative investments out there. This is a dangerous thought, as history proves that no real estate markets prior to this date have sustained such rapid growth in short periods of time.


Before we dive ourselves to the past, let's take a look at what could be potentially causing the real estate market to rise:

  1. COVID money-printing practices have greatly reduced the cost of borrowing - while this should be considered cyclical, the prolonged periods of cash injection into the market have created a non-reversible premium in real estate prices.

  2. Rising inflation rates have promoted higher salaries in most professional fields, increasing the affordability of potential buyers. Since the access to mortgages are primarily dependent on income, these prices will likely reflect the greater pocket-size of the bidders - especially in a market dominated by the sellers.

  3. Direct foreign investments from oversees - despite the Canadian real estate prices approaching dangerous territory, foreign investors (most notably Chinese investors) are happily dissolving their portfolio of domestic properties to invest in this lucrative market.

  4. Fear of missing out (FOMO) - when the market is hot, most average investors have the tendency to hyper-focus in this particular asset and increase their risk tolerance. This pressures the buyers to go "all-out", borrowing extensive amounts and liquidating all other assets to be able to have a place in the market.

  5. Airbnb - despite the pandemic driven turnovers in number of travelers around the world, the once prosperous practice of inflating rental prices based on Airbnb potentials have yet to be forgotten.

  6. COVID has negatively impacted the supply and production of newer buildings and houses, causing the average price of Canadian resale homes to soar.

  7. Conflicting interests and pressures from mediating agents (real estate agents and mortgage advisors) - this will always be a supplementary factor to the increase in real estate prices, but it certainly adds a "cherry on top" to rest of the factors outlined above.

Lessons from the Past: Japan's Lost Decade

Perhaps one of the greatest crashes in real estate market, Japan's financial crisis in the early 1990's teaches us one very important lesson: no prices will rise forever. Don't get me wrong, just like Canada today, Japan had a very strong and diversified economy branching into tech, manufacturing and financial sectors. What made it fall makes it even more troubling for the Canadians to see.


Although it's common to point fingers towards the Japanese policy makers, the real culprits of the story are the irrational investors themselves. Despite the unrealistic pricing models portrayed in the real estate markets in Japan, investors flocked to inflate an even larger bubble through aggressive borrowing and disposition of all other assets including stocks and bonds. They believed that a market this hot would be untouchable with rising concerns of deflation and regulations governing the real estate assets - hence, the FOMO fueled the crisis even further. When the economy is made up of debt, it needs to pay it back somehow eventually - and oh boy, it did. With mortgages being approved left and right in millions, banks had willingly placed themselves in a credit crunch all while having difficulties collecting the remaining funds that have already funneled through the market.


The main issue here lies in the choices that investors made as a collective representation of Japan's economy. Instead of funding and investing into assets that drive the economy to grow even further like new businesses or infrastructures that create new jobs and money making potential, they simply settled. All the growth and prosperity that they have aggregated over the prior decade were put into a colossus cash reserve: real estates.


Canada's Reliance on Real Estate Market


The Canadian economy is most certainly diverse with its rich resources in gold, copper, zinc, and most importantly oil. However, you may be surprised to find that real estate and financial lending services are the top GDP contributors for Canada.


Gross Domestic Product (GDP) of Canada in June 2021, by industry (source: Statista)

The result isn't that surprising, knowing how much funding has been contributed to the housing market in Canada. Our economy depends heavily on the prosperity of real estate market and its complementary services associated with these assets. In other words, the economy is built on billions worth of mortgages, and it expects us to continue taking risky borrowing practices to drive this unsustainable growth.


To lay foundations in organic growth of the Canadian economy, more investments need to be made in the equity segments of the market. We, as a collective representation of the economy, need to act more responsibly and promote growth of small and medium sized businesses in emerging sectors with a forward looking outlook. There is no denying that the pandemic and massive cash injections into the economy have created somewhat of an unclear and confusing environment for investors to think rationally, and most of all survive in this extenuating circumstances. However, history has thought us time and time again that relying on a single group of assets is a dangerous practice that should be avoided at all cost.


Take-aways


One simple solution to this type of market is to buy what you can actually afford. Your cashflows determine your affordability, and you should treat it as the final decision making factor when it comes to purchasing a real estate. Borrowing large sums of money will have a drastic impact on how you carry out your lifestyle, and if you don't have sufficient and consistent cashflow to fund the purchase over time, you will most likely suffer.


Think outside the social norm, and look into areas where there is less demand. We are often pressured into buying overpriced homes in bustling cities as a result of having social stigma and status associated with owning a property in premium locations. Look around you to see the sort of changes that are happening in our lifestyles; most of our needs are being fulfilled remotely such as ordering groceries and shopping online. COVID may have semi-permanently changed the real estate landscape, but it has also helped accelerate the technological progress in improving our lives. With many employers initiating work-from-home structures for present and future job opportunities, it's becoming more and more sensible to look for homes outside of popular locations.


Most importantly, it may be a good opportunity to look into other types of investment options that suits your current financial situations. Playing catch-up games in the already inflated real estate market by taking loads of debt is a highly risky practice, especially when your entire life is at stake. No financial asset is ultimately safe, and we don't need the history to repeat itself to teach our lessons again. Always invest what you can afford, and keep a diversified portfolio that are purposed for long-term investing.

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