Bad Strategy

A year ago today the average house in Canada sold for $348,178. Today the price is $356,687. The increase, about eighty-five hundred bucks, represents an annual gain of 2.4%. And while it’s free of capital gains tax (if you live there), it’s less than the current inflation rate of 3.1% in Ontario. In BC, inflation is just 1.5% but, whoops, the average home has actually lost value – a whopping 8.6%.

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Ditto for Montreal, which means real estate in the three major markets in the country is worth less in real or inflation-adjusted dollars than twelve months ago. Meanwhile, of course, the cost of owning one is higher, thanks to property tax, utilities, insurance, condo fees and furnace filters (can you believe what those suckers cost?).

For those who think paying down a 3% mortgage is an investment, buy a calculator.

In contrast, US stocks advanced 13.3% (the S&P 500), while the laggard TSX gained just 4% – but still beat your house. A balanced portfolio of 40% fixed income (various bonds and preferreds) plus 60% growth stuff (equity-based ETFs and REITs, for example) in 2012 returned about 10% (if you knew what you were doing). If this happened inside your TFSA or RRSP, no tax.

As I’ve said on this pathetic blog repeatedly, the three gods to worship are Diversity, Liquidity and Balance. Being a real estate junkie with the bulk of your net worth in  a house, or letting your spouse persuade you to accelerate mortgage payments and ignore investing, is a ticket to heartache.

The average mortgage rate for homes bought in Canada in 2012 was just 3.24%. The average house appreciated less than inflation. So, how does it even make sense shoveling precious after-tax dollars into something that’s essentially depreciating? But it’s exactly what most people are doing.

According to the mortgage brokers’ association’s latest report, Canadians are once again proving with their wallets they have absolutely no idea how to build wealth. A quarter of everyone renewing a mortgage opted for higher payments and one in seven made a pre-payment. People voluntarily increased their monthly mortgage payments in the past year by $3.5 billion. They dumped an astonishing $20 billion in lump sum payments against their home loans.

Consider a homeowner in Ontario, where inflation is 3.1%, stripping all the extra money from his family to pay off a $3.24% mortgage so he can build equity in a house worth less than last year. I rest my case. He’s flipped.

And, of course, we’ve only started to see absolute declines in the value of real estate. The reasons are legion, but here’s a good one even the mortgage brokers recognize. F’s big mortgage-shortening changes of last summer took aim at the 55% of people who can’t buy a house without a high-ratio mortgage. About 17% of those people who got a mortgage under the old rules would not qualify today. So, either home prices have to drop to maintain existing sales levels, or home sales in general will decline about 10% nationally.

So what?

So that equals 45,000 fewer sales a year. By the way, that’s close to twice the total number of properties sold in all of Vancouver last year (25,390).

And this is the effect of just one of the changes now in force. Also gone, remember, are cash-back mortgages at the banks and CMHC insurance for properties listed above $1 million, of which there are currently 3,500 in Greater Vancouver and 1,500 in the GTA. Add to this a condo glut, and it shouldn’t be too hard to see how 2013 will be shaping up for the housing market.

Lost on an entire generation, it seems, is the realization that real estate’s just another asset class. Its value fluctuates. It requires extreme leverage to acquire. It’s costly to buy and more costly to sell. You have no control over the rate on your debt. Nor political decisions affecting the market. Buy at the wrong moment in the cycle and you overpay. Sell at a poor time, and lose either value or liquidity.

Of course, financial markets are fickle, too. And you need a place to live.

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But amassing your family’s net worth in a house is a gamble I wouldn’t take. The fact millions now are should keep you awake tonight.