Smart Real Estate Investing in Turbulent times

With the ever changing commentaries on the Real Estate Markets in both Canada and the U.S. it is hard to really understand where they are going. Every week there seems to be a number of opinions: the Canadian real estate market is fine, or it is in a bubble situation, or the US market has hit bottom and now is the time to buy, or it is going for another drop, or it is on the rise.

Is there a way to improve your odds and reduce your risk when it comes to real estate investing? The answer is yes, through understanding the impact of events and actions beyond our local markets, local market research and understanding your risks tolerances. Let’s explore some of the larger issues here.

National Debt and Real Estate Demand

With the uncertainties of global economic conditions, real estate markets continue to face unclear future. How can you, as an investor take advantage of the uncertainties created by real estate investment changes?

In my previous newsletter, I spent some time discussing investment real estate and the role demographics and demand have in driving changes in different markets. This month, I’d like to take a broader view – and talk about national debt and what you can do in the current economy.

The World Economy

The World Economy continues to struggle as we head into the end of the year. Slower than expected growth, the looming Euro Debt Crisis, and alarm over economic risks and debt loads of several global economies have prompted many countries to adjust posted growth rates.

According to a recent Reuters article, Singapore, Thailand and Japan have indicated their economies are facing slower than expected growth. The central banks of Brazil and Indonesia have also cut interest rates. The one thing that we can be certain of, among all the uncertainties, is that the global economic recession caused by the international financial crisis will be chronic, “say Wang Qishan, the top official steering China’s financial and trade policy.

Graphically, the changes are best represented with the following graph:

Some other key facts:

  • There has been a sharp decline in economic activity in G-7 countries
  • Roughly 30 million people are unemployed globally – that’s almost equal to the entire population of Canada

Global Real Estate Markets

Over the last decade, housing prices globally have shifted substantially. A recent report from The Economist highlights some significant findings:

  • Since 2006, house prices dropped by 34% in America
  • In Ireland they fell 45% from their peak in 2007;
  • Denmark and Spain have experience around 15% of a drop.

In some countries, such as Australia, Canada and Sweden, prices wobbled but then surged to new highs.

To determine whether a continued global slump will occur, we need to consider affordability and income. Two measures to consider include:

  • Price to income: what a lender uses to assess whether, or not, a home is affordable for a borrower. Therefore if you do not earn enough money to cover your cost of living, plus the mortgage that you are interested in securing, then a lender may turn you down for a loan.
  • Price to rent ratio: house prices should reflect the expected benefits from home ownership: namely the rents earned by property investors (or those saved by owner-occupiers).

If the scoring of these measures are above average – then a market is considered overvalued.

Based on the average of the two measures, home prices are overvalued by about 25% or more in many of the markets within Australia, Belgium, Canada, France, New Zealand, Britain, the Netherlands, Spain and Sweden (see table). In contrast, homes in America, Japan and Germany are all significantly undervalued.

Does this mean we should turn our attention to a possible rebound of prices in undervalued markets like America? No. Although prices may have hit a low, there is no guarantee of an imminent bounce. It takes years for markets to recover. More than that, 4 million foreclosed homes may come onto the market, flooding supply which will keep prices low.

Are the overvalued markets likely to fall? Some economists believe that lower interest rates justify higher prices as people can secure bigger mortgages. Shifts in interest and mortgage rates may happen at any time. Although tighter credit regulations means it’s harder for homebuyers to get mortgages, although household debt burdens in relation to income leaves buyers exposed to unemployment or higher mortgage rates.

Prices do not necessarily need to fall sharply to return to fair value. Adjustment could come through higher rents and wages. With low inflation, however, it could take a decade or more before price ratios return to their long-run average in some countries.

Explore and compare global house prices with this interactive tool provided by the Economist.

Similarly, Andrew Stewart of David Cronheim Mortgage Corporation also points out:

“To navigate the current market, equity investors should tread water carefully and debt investors need to be wary of leveraged loans based upon inflated asset values. Existing borrowers should lock in as much money as their investments can support for as long as possible — more than 10 years is preferable. If owners have another method of deploying capital outside of real estate, it is time to sell, but not to buy more real estate at inflated values. “

Canada vs. US National Debt

Economic risk, national debt, employment, inflation and consumer confidence play an important role in shifting real estate demand across markets. According to an article in Canadian Business, historically, U.S. federal debt has more than quadrupled while Canada’s debt has increased by about 55% since 1990.

Why the discrepancy? From 1997 through 2008, statistics indicate that Canada made an effort to reduce debt and paid off over $90 billion. Over the last 10 years, U.S. debt has consistently risen, according to the PEW Research Center as a result of: recession related revenue declines (28%), defence spending (13%; cost of the wars on terror alone were over $2.4 trillion to the end of 2009 according to Homeland Security Research), and Bush tax cuts (13%).

Debt Crisis and Real Estate Investing

The global economy debt crisis impacts real estate investors in two main ways:

  • Inflation rates and
  • Overall interest and Mortgage rates

These rates have a significant effect on consumer confidence. Regardless of mortgage availability, mortgage rates or appraisals, consumer confidence determines if an investor considers selling, or completes on a contract.

For U.S. Markets, Robert Shiller of the S&P Case-Shiller home price index believes that, “A downgrade of U.S. government debt would plausibly raise interest rates, and that would communicate to mortgage rates, but more important would be the effect on confidence and our national spirit, which is so conflicted right now. It is harming our sense of confidence – that matters more than the direct effects on interest rates.”

Similarly, being thoughtful about personal debt is also important.

In Canada, recent survey from Canada Mortgage and Housing Corp. (CMHC) indicates that although Canadians are carrying a heavy personal debt load, it also shows that most Canadians are generally smart about handling their mortgage loans. Canadians tend to be conservative by nature and with regulatory constraints from the government; Canadians have managed to avoid the worst of the debt crisis.

“Survey findings indicate that 75 per cent of Canadian home buyers feel it is very important to pay off their mortgage as soon as possible. In fact, 39 per cent of recent buyers have their mortgage payment set higher than the minimum required. Further, since taking out their mortgage, 20 per cent of recent home buyers have already made a lump sum payment to their mortgage,” CMHC noted.

Final Thoughts

Regardless of the volatility in the global economy, smart real estate investing is about paying attention to the market through such key indicators such as affordability. Before you invest – ask yourself: If the interest and mortgage rates do shift by 2, 3 or 5 percent, will you be able to maintain your investments comfortably? As we have seen in some U.S. markets, being thoughtful about your personal debt load is important.

Another thing to consider is the source of your information. Do your due diligence, but also take the time to know where your data is coming from and understand what it actually represents. In the US, the latest stats from the Bureau of Labour statistics indicate inflation for October 2011 was 3.5 percent. By taking the time to dig a little deeper and reviewing how the calculation of the CPI (the measurement of consumer prices) was determined, we can see a very different result from


Get to the real facts in order to make informed decisions.

As I mentioned in my previous newsletter:

  1. Look at the key economic drivers in the market and consider the amount of speculation in the real estate market.
  2. Consider the cyclical nature or real estate – understand that you need to focus on where a market is in the cycle and how it will impact your overall portfolio.

Remember, regardless of the opportunity; take the time to make sure it fits with your long term real investing goals. Long term, well-located real estate is a solid investment if purchased at the right time based upon your desired real estate investing goals. However, the short and intermediate outlooks are somewhat more clouded – be prepared for shifts in prices, valuations and rate fluctuations.

By Andrew Schulhof
13 Dec 2011