Every time the stock markets go down for a sustained period, as they have over the last 12 months, investors tend to look at alternatives like real estate.
I often hear people say things like, "I have never lost money on real estate," or "my house has been my best investment."
Both statements are sometimes true, but they also might reflect a short memory.
In Winnipeg, we had 10-year periods when house prices have remained flat. Other cities have experienced house-price declines as high as 20 per cent, although not for a long time.
It's that "not for a long time" that can be a killer. We all tend to have short memories, and after a long period of increases, people forget there can be corrections. This is no different than late in a bull market in stocks -- people tend to forget that prices will drop at some point.
American homeowners are certainly learning this lesson right now. There is an index of U.S. housing prices called the S&P/Case-Schiller Home Price Composite Index, which measures house prices in 20 U.S. cities. This index shows that house prices for the three-month period ending in April 2008 were 15.3 per cent lower than the same three-month period in 2007.
That's bad news for homeowners, obviously, but also for the banking system and mortgage companies. Recall that many of these mortgages were issued at interest rates below market, with an adjustment clause some months later. In many cases, the homeowners cannot afford the new mortgage payments at the higher interest rates, and many are defaulting on their mortgages.
In a rising market, when the mortgage company can repossess the house and sell it to recover its money, the effect of this is less significant. However, after 18 months of declining house prices, many of these mortgage companies are finding the fire-sale price of the house only recovers a fraction of the outstanding mortgage.
This is one reason why many U.S. banks and, to a lesser extent Canadian banks, are taking huge write-offs as they set up large allowances for these loan losses. The collateral security for these loans is turning out to be worth a lot less than the banks thought. Every dollar they lose on a bad loan is a direct hit to their profits.
With two of the largest American banks recently announcing results that were better than the analysts' predictions, it's possible they've turned a corner. However, those results are based on future predictions of housing price trends, among other things. So far, U.S. house prices show no sign of strengthening.
In the recent Case-Schiller Index survey for the quarter ending April 30, 2008, housing prices were down 26 per cent in Las Vegas, 26 per cent in Miami and 25 per cent in Phoenix, compared to one year previous. In Canada, we depend more on market surveys conducted by real estate companies such as Royal LePage Real Estate Services. Cynics would say their research is biased toward optimism, but they have been doing this for a long time and have a pretty good track record.
The most recent survey, released July 18, shows Canadian house price increases easing, but few actual price drops. The exceptions were Edmonton and Calgary, where house prices declined 14.2 per cent and 5 per cent respectively, compared to the same three-month period in 2007.
Like most commodities, the price of housing is determined by the interaction of supply and demand. In Edmonton and Calgary, there are currently many more houses on the market than usual and buyers are reacting by waiting.
This survey forecasted continued positive momentum through the end of the year, with the average house price rising 3.5 per cent, but sales transactions declining by 11.5 per cent. It predicts Regina will have the greatest rise in house prices.
However, when I talk to people in markets like Victoria and Vancouver, they say they can "feel" a slowdown. This may simply be the elimination of bidding wars identified in the Royal LePage survey, or it could be that the survey is overly optimistic.
This all may be a moot point to anyone who is staying the same house for the next number of years. However, if you are planning on speculating in real estate investing, the data suggests you should not count on the kinds of price increases we've seen in the recent past.
A contrarian investor might be actively sniffing around some of the depressed US markets and looking for foreclosure opportunities, of which there are many. Keep in mind you need to get professional tax help in structuring the purchase.
Take good care.
David Christianson is a fee-only financial planner and investment counsel with Wellington West Total Wealth Management Inc. His column appears Fridays. You can e-mail him at dchristianson@wellwest.ca
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