Stressed investors keep eyeing the profits in real estate while equity markets continue their wild ride

It’s going to crash, it’s going to crash. How many times have we heard this about the Canadian housing market? Sometimes commentators use more tempered language to describe a predicted “pullback” or a market that is going to “moderate.” The problem is that outside of the 2008 recession, when prices corrected 10% followed by a boomerang recovery, it has not been true.

How do you are argue with almost 13 years of uninterrupted growth when the average sale price of a home in Canada has climbed from $152,365 in 1998 to $366,105 year to date in 2011.

That’s a 140% increase, but who’s counting? Apparently, a few investors.

Canada Mortgage and Housing Corp. says September new-home construction on an annualized basis was above 200,000, a level consistently hit on a yearly basis from 2002 to 2008. But this time out, a majority of the new construction was condominium apartments.

Existing-home sales, though not as buoyant, have stayed above 2010 levels and even added another 8.2% price appreciation. Why would consumers turn away from housing when all it does is go up? Not to mention the low interest loans that are there for the asking.

At one point, there was some tough talk about tightening lending, but the only substantial change has been shorter amortization periods. You can still get into the market with as a little as 5% down and borrow at rates below 3%.

And yet people like Benjamin Tal, deputy chief economist at CIBC World Markets, insist real estate’s prominence will fade over the next decade.

“This real estate boom is over. It’s not crazy to invest now, but it’s not the best way to utilize cash,” says Mr. Tal, adding the condo market has been influenced by foreign investors wanting to get their money out of their country of origin and diversify their wealth.

Don’t tell that to investors eyeing the profits in real estate while the equity markets continue their roller-coaster ride.

But what this boom has done for real estate is level the playing field with stocks. The S&P/TSX composite index total return over the past 13 years is actually about 135%, just below real estate’s 140% gain. Go back to 1980, when the Canadian Real Estate Association first started tracking average price, and real estate’s 446% return, based on average sales price, also compares with the market.

Much of today’s activity is in condominiums even though the costs of carrying such an investment have risen dramatically. Investors are still banking on a rising market.

Urbanation Inc. executive vice-president Ben Myers says the average condominium in Toronto – the biggest market of its kind in North America – sold for about $490 per square foot in the second quarter. Based on about 750 square feet, that’s $367,500.

Your carrying costs would include a mortgage and with 25% down and about a 2.4% interest rate, your monthly mortgage payments would be $1,222.67. The average condo fee is 47¢ per square foot, so add another $350 per month, plus, say, another $300 per month for taxes.

The problem is those approximate $1,900 in costs, which don’t include heat and hydro, are more than rental revenue. The average Toronto condominium rents for $2.18 per square foot, putting your condo income at just over $1,600 per month.

That gaps seems worth the risk because condominiums in Toronto have appreciated at an average rate of 7% to 8% over the past 15 years. Condominiums also have the added attraction of requiring minimum cash up front until they are registered. It can take three years to build a condominium, so you can get away with putting as little as 20% down before you have to come up with the full amount.

The math is simple. You put $73,500 down on that condo and hope the value of the $367,500 condo jumps to $450,000 in three years, based on a 7% increase. That’s an $82,500 return and, even if you take out $20,000 for transaction costs, you are left with $62,500 profit, or an 85% return on your money in three years.

It’s attractive to many. Financial planner Ted Rechtshaffen has a client with a net worth of $2-million who owns seven condominiums.

“It is a strategy that has worked,” he says, adding the model could come tumbling down if interest rates rise. “If you strip it all down, it’s a highly leveraged strategy. If you are of the view that real estate only goes up, highly leveraged is a smart thing.”

Copyright (c) National Post

Leave a Reply

Fill in your details below or click an icon to log in: Logo

You are commenting using your account. Log Out /  Change )

Facebook photo

You are commenting using your Facebook account. Log Out /  Change )

Connecting to %s