Real estate is a low risk, high return investment. Not.

There is a perception among Canadians that investing in real estate is easy money. A recent Globe and Mail article, by Bob Carrick, spoke of an 81 year old man who was thinking of cashing in his bank guaranteed term deposits and using the funds to buy real estate. He thought real estate returns would be much higher and the risk was the same between the two investments.

There is no such thing as a low risk investment with consistently high returns. If there were such an investment, then everyone would buy, pushing up prices until the investment returns were equivalent to other low risk investments. This may have already happened in Canada, but perhaps real estate is different.

Is Canadian real estate different from other investment assets? Yes and No.

Yes, it is different because demand is driven by people who need shelter. People would rather be house poor than homeless. As well, many people believe that municipalities have done a poor job of urban planning and have created a supply shortage.

But in the long run underlying fundamentals still apply. When supply catches up to the population in a city, in the long run the annual average cost of shelter cannot exceed the after tax incomes of the people living there. A quick glance at the charts below from the Royal Bank Housing Trends and Affordability Report will tell you that Vancouver and Toronto are in trouble. Keep in mind that most Banks will not approve you for a mortgage if your ownership costs exceed 35% of your gross income.

According to Statistics Canada, the median Metro Vancouver income is $63,365 and the annual cost of home ownership (assuming someone has a couple of hundred thousand tucked away for a down payment) is more than the annual income of 50% of families.

The condo market in Toronto is just as bad. The median Metro Toronto income is $65,439 and the annual cost of home ownership is almost equal to the annual before tax income of most households.

In other words, at current real estate prices the majority of households in Toronto and Vancouver can not get a mortgage to buy a condo.

Before you pour your savings into real estate heed the warning in the Globe and Mail article, “prices could be at the high end of the cycle”. Whereas someone younger could financially recover IF the market was to turn, the 81 year old investor should NOT take that kind of risk!