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23 Feb

Canadian real estate sales down but prices are up

General

Posted by: Mike Hattim

The resiliency of the Canadian housing market has to impress even the most cynical observer. And while the consensus even among industry insiders is the days of double-digit percentage price increases are over, nobody is expecting an American-style housing collapse in Canada. “The fear proved to be unfounded,” says Pascal Gauthier, a senior economist at Toronto-Dominion Bank. He points out average prices in Canada only dropped 13% from peak to trough. Other than a brief blip in 2008, the average home price has been on a tear since 1996, reaching almost $340,000 in 2010. A decade ago, it was $163,992.

Alas, the good times are about to end. Gauthier says prices will actually go down in 2011, albeit by less than 1%. By 2012, the loss could be 1% to 2%. Even real-estate companies are not overly optimistic. For example, Re/Max says Canadians can expect an average 3% price increase in 2011. Such uncertainty doesn’t necessarily mean abandoning the housing market in the coming years. Indeed, it may even be time to take some of that bloated equity in your principal residence and bet on an investment property, such as a condominium, cottage or perhaps even something in the moribund real-estate market down south.

Scott Plaskett, a certified financial planner at IronShield Financial Planning in Toronto, isn’t opposed to using home equity to buy other assets. “I recommend it in the right circumstances,” says Plaskett. “I wouldn’t suggest just real estate. But real estate is a great option, because it’s one of those assets that can produce cash flow while holding the assets.”

But finding condominium investment properties that produce positive cash flow is getting tougher and tougher in Canada because of the high valuations. Ben Myers, editor of Urbanation Inc., which tracks Toronto’s condo market, says about 50% to 60% of the city’s condos are now being bought by investors looking for hefty price gains. “People have been playing off that. Over the last three years, we’ve had 7% to 9% annual price increases,” says Myers. Those price increases have made some people rich. If you bought a new unit for, say, $300,000, it would be worth about $367,000 by the time it was built, based on 7% appreciation over three years. That’s more than 100% return on your 20% downpayment, if you flipped the condo after taking possession.

But a flatter market means investors may be stuck carrying their properties and making money that way is more difficult. To carry a 500-square-foot condominium, which can easily cost $300,000 in downtown Toronto, you would need to recoup $1,900 per month based on a $240,000 mortgage. Here’s the math: monthly mortgage payments are about $1,275 based on 4% interest and amortized over 25 years, and then add condo fees of $250, taxes of $250 and $125 for heat and hydro. To reduce costs, Myers says some investors are choosing variable-rate mortgages. That can save $150 a month in carrying costs, but leaves investors heavily exposed to rising rates. “The worry is if rates go up, are all these investors going to [sell] and flood the market with units?” he says. “At more than $600 a square foot to buy, can rents go to $2,000 for a 500-square-foot unit?” Renters are willing to pay more for condominiums than apartments, according to a Canada Mortgage and Housing Corp. report at the end of 2010. For example, the average rent for a two-bedroom condominium in Vancouver was $1,610 versus $1,195 for a similar conventional apartment. But that difference won’t cover an investor’s costs.

Don Campbell, founder of the Real Estate Investment Network in Calgary, uses an investing formula that looks at an area’s growth in gross domestic product. “GDP growth leads to job growth and that leads to in-migration growth about 12 months later,” he says. The more new people there are, the lower rental vacancies go, and the higher rents go. That leads to increased demand for investment property and a better return on investment. “That trickles into the resale market because people say, ‘Rents are so much, I’ll just buy something,'” says Campbell. Using that analysis, Campbell likes Calgary, Edmonton and — in Ontario — Hamilton, Kitchener-Waterloo and Cambridge.

Canadians looking for something cheap are also eyeing the United States, because property prices have collapsed and the dollar is at par. But before rushing south, Philip McKernan, the author of South of 49 and Fire Sale, two books on investing in the U.S., says Canadians first must distinguish between buying a property as an investment and buying one for recreational use. “A vacation property is not an investment,” he says. “You buy it for ego to say you own a four-bedroom townhouse on a golf course so you can keep a toothbrush there four weeks a year.”

If investing, McKernan says Canadians should go for direct investment, but look for a management team that can handle the property. “I’d look for jurisdictions not in the traditional sun-belt,” he says. “Look for a diverse economy, not some highly speculative vacation area.” But McKernan is not a fan of using existing home equity to buy vacation or investment properties. “Some of them are leveraging their homes to 95% to buy in the U.S. It could come back to haunt them.”

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5.7%

Average price increase last year for a Canadian home, which cost an average of $338,676, compared to $320,333 in 2009

3%

Decline in the number of home sales, which dropped to 451,825 units from 465,251 units in 2009