Why the Real Estate Market is Pooched, and How That Will Impact Your Investments

by JDH on November 28, 2015

This is, ostensibly, an investment blog, so why would I veer off  the well traveled highway to share my thoughts on real estate?

Why not?

Also, a significant portion of the Canadian economy is based on real estate, so a sickness in real estate can very quickly morph into a general market malaise.  Think about it: For the last few years, particularly in booming markets like Vancouver and Toronto, every house goes up in value, and interest rates are low, so it’s easy to borrow against the rising equity in your house to generate cash to invest in the stock market.  If real estate turns down, it could have a dramatic impact on the stock market.

I suspect that real estate will turn down, for many reasons, the main one being that young people can no longer afford a house, and/or have a desire to buy one.

The job market isn’t great.  When I graduated from university, almost 30 years ago, the job market was robust.  I had many jobs to choose from.  Today, not so much.  You may start as an unpaid intern, and then hope for the best.

I also graduated debt free.  My tuition was less than $1,000 per year, so it was possible to pay for tuition and books from a good summer job.  My parents helped with living costs, and that was it.  Today tuition can run $10,000 or more per year, and with books, computers and living expenses the costs can be double that.  It’s impossible to pay for university with a summer job, so unless your parents are helping, you need a student loan.  So now you graduate with a mountain of debt.

I bought my first house two years after graduation.  I was levered to the hilt, but I did it.

Today that’s impossible.  You can’t buy a house when you have $50,000 in student loans and you are working at Starbucks for $12 an hour.

But there is more to it than that.

I have two teen-aged sons, and I don’t think either of them has watched television since we all watched the Super Bowl back in February (mostly for the commercials).  They don’t watch TV.  What they do watch is their computers and tablets and phones.  They live in a virtual world.

When they leave the family home, will they care about a big house in the suburbs?  No.  All they will care about is a place with a great internet connection, because they live largely in a virtual world.  Real estate is of less importance.

Young people with student loan debt and lousy jobs don’t start families, and they don’t buy houses.

I have long predicted that the Fed will not raise interest rates, ever.  Presumably I will be eventually proven wrong, perhaps as early as next month, but even if interest rates increase it will be a very minor amount.  The Fed can only touch the brakes lightly; they can’t stomp on them or the economy will careen into a ditch.

But it’s not just higher interest rates that we have to worry about.  The real estate market can crater even if rates stay the same.  Why?  No growth.

If you are a real estate investor, as a landlord you have two ways to make money: monthly cash flow, or capital appreciation.  Many landlords today generate negative cash flow, but they don’t care as long as house prices increase.  But if real estate values stagnate, there is no point bleeding cash each month.  Eventually you sell, and when enough people sell, down go prices.  Watch for it.

When that happens, that loss of wealth is gone.  There are no profits to invest in the stock market, or anywhere else.

Conserve your cash, and prudent in your investments, because long term that’s the only solution.

Thanks for reading; back to the stock markets next week.