3 Easy Ways to Protect Your Portfolio From Canada’s Housing Bubble

Worried about Canada’s housing market? Then avoid National Bank of Canada (TSX:NA), Genworth MI Canada Inc. (TSX:MIC), and Home Capital Group Inc. (TSX:HCG).

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When it comes to Canada’s housing bubble, opinions are varied.

Homeowners are loving the price increases, especially in Toronto and Vancouver. Many folks making middle-class incomes are sitting on well over $1 million in real estate that’s paid off and can be sold tax free. Obviously, these people want the market to keep climbing.

On the other hand, we have younger folks who feel priced out of the market. These people love everything about the life in the city except unaffordable housing. As a reaction to this, many of them will loudly proclaim housing prices are nuts and the whole country is in a bubble.

Many investors choose to stay firmly indifferent to this debate, thinking that no matter the outcome, their lives won’t be affected. This is especially true for somebody with a paid-off house in one of Canada’s smaller markets. If a homeowner in Windsor, Ontario loses $10,000 off the value of their home, it’s not a big deal.

For the most part, this is a good attitude to have. The only problem is if Canada’s housing bubble pops in a big way, investor portfolios could get caught in the crossfire. That’s bad news, especially for somebody with property in an overheated market.

Here are three ways investors who are worried about the housing bubble can protect themselves.

Avoid the banks

Canada’s banks have done a nice job protecting themselves from the housing bubble by using mortgage default insurance to their advantage.

If a borrower wants a mortgage with a down payment of less than 20% of the value of a home, they’re forced to buy default insurance, which protects the lender in case of any financial difficulties. This protection is very good news for Canada’s lenders. It doesn’t protect them from everything, of course, but it does shield them from the riskiest of loans.

Still, it’s obvious that Canada’s banks will get hit hard by investors during any long-term real estate correction. National Bank of Canada (TSX:NA) would likely get hit the hardest because it has very Canadian-centric operations. Its competitors all have sizable international diversification, which should help protect them in the case of weakness from Canada.

Avoid the two scapegoats

One thing we learned from the 2008-09 U.S. crash was that investors will sell first and ask questions later. A similar thing will happen with Canadian companies most exposed to the market.

The most obvious choice is Genworth MI Canada Inc. (TSX:MIC), Canada’s only privately owned mortgage default insurer. The company, which offers identical products as CMHC, the government-backed default insurer, will obviously be in a bad place if the market crashes.

The other more regionally specific choice is Home Capital Group Inc. (TSX:HCG), which dominates subprime lending in the Toronto area, one of the areas most identified with the bubble. Additionally, Home Capital didn’t really help itself by disclosing that some $1.9 billion worth of mortgages on its balance sheet are possibly fraudulent; although, in the company’s defense, these came from a rouge group of mortgage brokers accused of falsifying documents.

Sell and rent

Admittedly, this isn’t such an easy solution, but it could put hundreds of thousands of dollars in your pocket.

Because owning property is such a popular investment, landlords are forced to accept anemic returns from cash flow. This has made renting more affordable than ever. It’s the natural result of today’s market.

There are thousands of homeowners in Toronto sitting on at least $1 million in home equity. If that cash is properly invested in a portfolio of dividend stocks instead of sitting idle, it could spin off between $30,000 and $40,000 per year in income, easily enough to cover rent in a smaller place.

Or, better yet, leave town. Yes, I know it’s hard to leave a place that’s grown to become home. But Toronto homeowners who move just a few hours away can find affordable housing in communities that still offer many of the amenities of home, and they can lock in impressive gains in the process.

Should you worry?

Predicting a crash is hard; I get that. Pundits have been calling for a crash for years, and they’ve been wrong this whole time.

But at the same time, I argue that it’s prudent for investors to lighten their exposure to real estate. At this point in the cycle, it’s just smart.

This article represents the opinion of the writer, who may disagree with the “official” recommendation position of a Motley Fool premium service or advisor. We’re Motley! Questioning an investing thesis — even one of our own — helps us all think critically about investing and make decisions that help us become smarter, happier, and richer, so we sometimes publish articles that may not be in line with recommendations, rankings or other content.

Fool contributor Nelson Smith has no position in any stocks mentioned.

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