Investor Alert: ‘Your House Makes More Than You Do’

Your House Makes More Than You Do

If anyone had any doubts about the strength of the real estate market then think again. Not only are Canadians more confident in the housing market than the overall economy, but the lack of supply is driving prices higher than ever before.

A recent bulletin by Sal Guatieri, Senior Economist and Director at BMO Capital Markets, titled “Your House Makes More Than You Do” is a real eye-opener. The research note by Guatieri brought to light what many fail to realize, which is that as much as we think we are in a “bubble”, the reality is that the shortage of housing supply is causing real estate prices to rise faster than household incomes on an annualized basis.

This isn’t just a Toronto narrative, but also one that is reflected across the Canadian real estate market. While everyone is hard at work or possibly out of work due to the pandemic, it is interesting that for those who own a home their real estate investment is generating more wealth than their 9 to 5 jobs.

Real estate investment is generating more wealth than 9 to 5 jobs

Guatieri started the bulletin by emphasizing the risks associated with rapid asset growth by writing, “asset prices start to raise red flags when they consistently outrun growth in underlying income or earnings.”

And although this is a phenomenon happening across Canada, the growth is more evident in the Province of Ontario, which is home to the largest city in Canada and biggest economic driver for the entire country: Toronto.

“House prices are not only rising faster than family income, they are rising more than total annual income,” emphasized Guatieri.

To help illustrate what Guatieri is implying, let’s take a quick look at the chart below, which shows benchmark prices of different cities on a year-over-year basis across Ontario. For example, according to CREA, the benchmark price in Woodstock was $381,100 in February 2020 compared to $520,600 in February 2021, which is an annual increase of $139,500. 

Similarly, in both Greater Toronto and Hamilton-Burlington, the benchmark prices were $844,600 and $641,100 in February 2020 compared to $969,600 and $833,100, which are both increases of $125,000 and a whopping 192,000 respectively.

Benchmark prices of different cities on a year-over-year basis across Ontario

What you’ll find notable from this data is that the stereotype of Toronto being the only city with a lot of exuberant pricing in the housing market is simply not true. Many other municipalities close to Toronto saw annual appreciation of home prices well beyond average household incomes for those regions.

When you compare this data to the annual family income of each of these regions you will quickly realize that average household incomes fall short of coming close to the passive earnings achieved through the very home you live in. For example, while Woodstock is racking in a healthy $139,500, the total median household income in 2018 for this region was only $86,970.

Similarly, when we examine the data from Toronto we see that while this region appreciated $125,000 year-over-year in February 2021, the total median household income in 2018 was only $86,670 in Toronto. Also, while the Hamilton-Burlington region saw appreciation of $192,000, the median household income in Hamilton was only $95,680 in 2018.

Now when you compare Toronto’s appreciation to household income differential to that of Woodstock or Hamilton, you will quickly realize that the bigger issue of home price appreciation to household earnings is a much larger problem in municipalities outside of Toronto. The fact that you have housing earning a staggering $96,320 more than household earnings in Hamilton is quite eye opening. Meanwhile, in Toronto the price to earnings gap is only $38,330, which seems to suggest a more balanced appreciation versus other municipalities outside of Toronto that are clearly more speculative in nature when examining economic growth data.

What is Causing the Surge in Real Estate Prices?

There are a number of variables driving up real estate prices recently, including low supply, low interest rates, and the simple fact that Canadians have FOMO - the “fear of missing out.”

When we look at low supply we can see that there is a shortage of housing, particularly within the GTA. Across the GTA, there are only 1.5 months of inventory of housing supply at current sales levels for all home types as recorded by TREB in February 2021. We are clearly in a seller’s market as there should be at least four to six months of inventory in a balanced market.

Adding to this shortage are low interest rates, which are beneficial for new home buyers as a way to get into the market, but presents inflationary risks to the market if sustained over a long period of time. The risk of low interest rates is that they increase real estate buying exuberance and can result in some people taking on more debt than they can realistically manage over the long term.

Then there is real estate FOMO, which results in people flooding the market to buy because they don’t want to miss out on a potential opportunity. FOMO can help explain the recent trend of dozens of bidding wars and aggressive buying activity present within the Canadian housing market.

Real estate prices are likely going to continue rising throughout 2021

Take Away for Investors

Investors should reflect on recent events in the housing market by understanding that yes this is a good time to invest in the condo market, particularly since the price gap between high-rise and low-rise homes are now at an even greater disparity than ever before.

The recent price growth within the real estate market was expected, even during the noise of the pandemic when some media and real estate experts were claiming the market was going to collapse because of a grand “exodus” from major cities. This simply isn’t true and current events in the real estate market prove this.

There is no one answer on how you should respond to this hot real estate market. In certain circumstances it makes sense to sell and acquire capital growth that you can reinvest in two more real estate projects. But, it may also be smarter for some investors to hang on to their current portfolios for long term planning needs.

Real estate prices are likely going to continue rising throughout 2021 with a return to normal in 2022 with more moderate appreciation rates.

Investors should also be calculated and only invest within their budget to avoid buying up more real estate than they can chew. If you’re a new investor, rather than buying three or four condos, perhaps start with one and learn how to manage that single investment properly before taking on more debt or liability. Real estate is a great asset, but it still needs to be managed well for long term success and financial freedom.