The real estate debate: boom or bubble?

As with all rallies, there have also been concerns that the market was in bubble territory — concerns that have yet to be proven right.

According to the T. Stenner Group at CIBC Wood Gundy’s True Wealth Report, an annual survey of high net worth individuals, wealthy investors have become wary of the real estate market, with 89% saying real estate was either “expensive” or “somewhat expensive.”

The survey found 62% of respondents had sold off some of their real estate holdings in the past year, and 67% expect value to decline in the near future. Only 12% said they would invest in real estate if they had to reallocate 20% of their assets tomorrow.

“If you sold that piece of real estate, could you invest the money elsewhere and get a better rate of return?” asks Marc Lamontagne, CFP, at Ryan Lamontagne in Ottawa. “If the rental property can earn a greater rate of return than a Government of Canada bond, then it makes sense to be in rental properties. On the other hand, if I could make more money on the bond, why would I hold a piece of real estate?”

In essence, the rising property value acts to reduce the yield on the investment, unless the rental income keeps up. With the torrid pace of capital appreciation in some of Canada’s key urban markets in recent years, he says it only makes sense that the wealthy would take some of their cash off the table.

The Bank of Canada has been gradually raising interest rates, 25 basis points at a time, tacking on 1.25% since September 2005. The Bank Rate now stands at 3.75%, and retail lenders have boosted their prime rates, to 5.5%, as well as their mortgage rates.

Lamontagne says he does not expect interest rates to rise too dramatically in the near future, although he cautions that interest rate movements are notoriously hard to predict. But he says there are few pressures to drive the BoC to raise rates very quickly.

As a result, he says real estate prices may experience slower growth, or perhaps plateau, but he does not expect declines.

“Money is still pretty cheap, whether it’s at 4.5% or 5.5%,” he says. “The Bank of Canada has been pretty good at keeping rates fairly low, so I don’t think there’s a huge danger of interest rates going very high as they have in the past. There just isn’t the same pressure.”

For mortgage holders with a floating rate, he says they should sit tight, assuming their tolerance for uncertainty has not changed since they took out the mortgage. For homeowners on a tight budget, who need to know exactly what their payments will be, they may want to lock in.

The supply side

The Canada Mortgage and Housing Corporation reported continued strength in housing starts earlier this week, with construction commencing on 240,900 new units, down slightly from 248,100 units in January.

“Despite the modest decline, the rate of housing starts in February continued to be very strong.” said Bob Dugan, chief economist at CMHC’s market analysis centre. “However, we expect activity to moderate over the course of 2006, as higher mortgage carrying costs due to rising house prices and modest mortgage rate increases contribute to a softening of demand for both existing and new housing.”

Strong housing starts indicate continued interest in the housing market, but at the same time, the increasing supply could help to drive prices lower. The strong top line number also belies a schism in the Canadian market, as dramatic increases in the west counterbalance declining starts in the east.

In British Columbia, housing starts increased 22.6% to 39,100 units. Across the prairies, starts rose 11.5% to 45,400 units. Meanwhile, urban starts in Ontario have fallen 15.1% to 73,700 units, while the Atlantic provinces have seen a decline of 16.8% to 10,900 units. In Quebec, starts were down 8.8% to 39,200 units.

These numbers reflect the differing economic fortunes between east and west, as energy drives growth in the west and vanishing manufacturing jobs cut into eastern economic performance.

Capital value growth rates more than doubled in 2005, according to a report from the Institute of Canadian Real Estate Investment Managers and Britain’s Investment Property Databank. That sent the total return on real estate to 18.7% for the year, up from 13% in 2004.

“An insatiable appetite for real estate as an asset class is driving values up,” said Phil Tily, director of International Operations at IPD. “All property sectors enjoyed stronger capital growth in 2005.”

As reflected in the booming construction starts, Alberta was a hot market for real estate investors, with ICREIM reporting investment gains of 26.5% in Calgary and 23.4% in Edmonton. Real estate returns were somewhat lower in the eastern provinces, with Toronto and Montreal posting gains of 16.4% and 15.2%, respectively.

But within these gains, residential returns were the lowest, at 9.9%, compared to returns in the retail and industrial areas, at 21.4% and 17.6%, respectively.

Filed by Steven Lamb, Advisor.ca, steven.lamb@advisor.rogers.com

(03/10/06)

Steven Lamb

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Real estate values have been on a tear for the past five years in many parts of Canada, as low interest rates have encouraged investors to enter the housing market. With easy access to cheap money and innovations such as “zero-down” mortgages, many Canadians have dipped their toes into real estate as an investment.

As with all rallies, there have also been concerns that the market was in bubble territory — concerns that have yet to be proven right.

According to the T. Stenner Group at CIBC Wood Gundy’s True Wealth Report, an annual survey of high net worth individuals, wealthy investors have become wary of the real estate market, with 89% saying real estate was either “expensive” or “somewhat expensive.”

The survey found 62% of respondents had sold off some of their real estate holdings in the past year, and 67% expect value to decline in the near future. Only 12% said they would invest in real estate if they had to reallocate 20% of their assets tomorrow.

“If you sold that piece of real estate, could you invest the money elsewhere and get a better rate of return?” asks Marc Lamontagne, CFP, at Ryan Lamontagne in Ottawa. “If the rental property can earn a greater rate of return than a Government of Canada bond, then it makes sense to be in rental properties. On the other hand, if I could make more money on the bond, why would I hold a piece of real estate?”

In essence, the rising property value acts to reduce the yield on the investment, unless the rental income keeps up. With the torrid pace of capital appreciation in some of Canada’s key urban markets in recent years, he says it only makes sense that the wealthy would take some of their cash off the table.

The Bank of Canada has been gradually raising interest rates, 25 basis points at a time, tacking on 1.25% since September 2005. The Bank Rate now stands at 3.75%, and retail lenders have boosted their prime rates, to 5.5%, as well as their mortgage rates.

Lamontagne says he does not expect interest rates to rise too dramatically in the near future, although he cautions that interest rate movements are notoriously hard to predict. But he says there are few pressures to drive the BoC to raise rates very quickly.

As a result, he says real estate prices may experience slower growth, or perhaps plateau, but he does not expect declines.

“Money is still pretty cheap, whether it’s at 4.5% or 5.5%,” he says. “The Bank of Canada has been pretty good at keeping rates fairly low, so I don’t think there’s a huge danger of interest rates going very high as they have in the past. There just isn’t the same pressure.”

For mortgage holders with a floating rate, he says they should sit tight, assuming their tolerance for uncertainty has not changed since they took out the mortgage. For homeowners on a tight budget, who need to know exactly what their payments will be, they may want to lock in.

The supply side

The Canada Mortgage and Housing Corporation reported continued strength in housing starts earlier this week, with construction commencing on 240,900 new units, down slightly from 248,100 units in January.

“Despite the modest decline, the rate of housing starts in February continued to be very strong.” said Bob Dugan, chief economist at CMHC’s market analysis centre. “However, we expect activity to moderate over the course of 2006, as higher mortgage carrying costs due to rising house prices and modest mortgage rate increases contribute to a softening of demand for both existing and new housing.”

Strong housing starts indicate continued interest in the housing market, but at the same time, the increasing supply could help to drive prices lower. The strong top line number also belies a schism in the Canadian market, as dramatic increases in the west counterbalance declining starts in the east.

In British Columbia, housing starts increased 22.6% to 39,100 units. Across the prairies, starts rose 11.5% to 45,400 units. Meanwhile, urban starts in Ontario have fallen 15.1% to 73,700 units, while the Atlantic provinces have seen a decline of 16.8% to 10,900 units. In Quebec, starts were down 8.8% to 39,200 units.

These numbers reflect the differing economic fortunes between east and west, as energy drives growth in the west and vanishing manufacturing jobs cut into eastern economic performance.

Capital value growth rates more than doubled in 2005, according to a report from the Institute of Canadian Real Estate Investment Managers and Britain’s Investment Property Databank. That sent the total return on real estate to 18.7% for the year, up from 13% in 2004.

“An insatiable appetite for real estate as an asset class is driving values up,” said Phil Tily, director of International Operations at IPD. “All property sectors enjoyed stronger capital growth in 2005.”

As reflected in the booming construction starts, Alberta was a hot market for real estate investors, with ICREIM reporting investment gains of 26.5% in Calgary and 23.4% in Edmonton. Real estate returns were somewhat lower in the eastern provinces, with Toronto and Montreal posting gains of 16.4% and 15.2%, respectively.

But within these gains, residential returns were the lowest, at 9.9%, compared to returns in the retail and industrial areas, at 21.4% and 17.6%, respectively.

Filed by Steven Lamb, Advisor.ca, steven.lamb@advisor.rogers.com

(03/10/06)

Steven Lamb

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