BoC doesn't need to be aggressive and risk bringing the economy down: Economist
A dramatic reversal in the Canadian housing market is sending shockwaves through homeowners counting on their properties to help finance their retirement.
A home is the single largest investment for most Canadians and watching its value decline can be gut-wrenching. As the Bank of Canada boosts interest rates to combat inflation, early data is pointing to a steep drop in home sales activity and resulting price declines.
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While the fallout is nowhere near a bursting bubble that pundits have been warning about, a new report from the economic team at Desjardins said home prices could plausibly fall 15 per cent from their 2022 peak by the end of next year.
Those who view their home as an investment should not be surprised that prices move in both directions but it is a reminder of the importance of diversification in a broader investment portfolio when it comes to growing their household net worth.
What goes up, must come down
A home, on one hand, is like no other investment because it is literally the roof over your head. If the stock market goes bust, you still have a place to live at the end of the day.
But if you set aside the emotional aspect of hearth and home, it is like any other investment because it can be expected to hold an intrinsic value that can grow over time. Being able to live in it instead of paying rent is much like a dividend.
Compared with any other investment, the 15 per cent decline that Desjardins is forecasting over a period of less than two years is pretty mild; especially if you factor in some of the double digit year-over-year increases before and during the pandemic.
According to the Canada Mortgage and Housing Corporation (CMHC), the average annual increase in property values over 20- and 30-year periods have exceeded five per cent since the end of the Second World War. That has coincided with much more volatile stock markets for Canadians who invest in equities for retirement through company pension plans and Registered Retirement Savings Plans (RRSP).
Why it is important to diversify?
The advantages of diversification for long-term investors is undisputed. You can limit risk and expose your portfolio to a vast array of opportunities by diversifying across asset classes (equity versus fixed income), sectors and geographic regions.
Real estate is just one sector and does not move directly in tandem with other sectors such as Chinese equities or technology stocks, for example. While house prices currently face double-digit declines, as another example, energy stocks are experiencing double-digit increases. A year ago, it was the other way around.
The long-term objective is steady growth for the entire portfolio without having to lie awake at night worrying about your finances.
Diversification within real estate
The biggest shortfall for your home as an investment is its lack of diversification. Your piece of residential real estate is a sub-sector in one geographic region. A lot could go wrong.
Real estate has three basic sub-sectors; residential, commercial and industrial. The best way for average investors to get exposure to a broad mix of all three is through real estate investment trusts (REITs).
There’s no limit to how diversified a REIT can be. InterRent REIT and Killam Apartment REIT, as examples, hold multi-unit residential properties across Canada. BTB REIT holds commercial, office and industrial properties concentrated in Quebec. RioCan and SmartCentres REITs hold traditional bricks and mortar retail businesses.
Investors can also hedge risk by diversifying across sub-sectors. Bricks and mortar REITs, for example, have been hit hard by the double-whammy of the pandemic lockdown and the ongoing trend toward e-commerce. At the same time, the move toward e-commerce has increased demand for REITs that hold industrial properties specializing in warehousing, logistics and distribution.
Other REITs capitalize on shifting demographics by investing in seniors housing as the influx of baby boomers age.
If that’s not enough diversification, you can hold all the major REITs listed in Canada through the iShares S&P/TSX Capped REIT exchange-traded fund.
ETFs generally charge an annual fee based on a small percentage of the amount invested, so do your homework or speak with a qualified investment advisor.
Payback Time is a weekly column by personal finance columnist Dale Jackson about how to prepare your finances for retirement. Have a question you want answered? Email firstname.lastname@example.org.