2020 has been a banner year for Canada’s housing market. Despite a recession and widespread unemployment, house prices have risen 17% year over year. The magnitude of the increase has varied by province. In New Brunswick, house prices have gone up 31%, while in Saskatchewan, they’ve barely budged.
In most major housing markets, the gains this year have been substantial. But believe it or not, that may actually be a reason to worry. According to StatCan, 76% of Canada’s wealth was in real estate in 2018. Since then, the percentage has likely grown. Over the last few years, house prices have soared, while wages have grown much less. This means that if the housing bubble popped, Canadians would get a lot poorer.
Housing: The one thing Canadians are optimistic about
In 2020, Canadians aren’t optimistic about many things. Housing is one of the few they are bullish about.
Every week, the firm Nanos polls Canadians about their opinions on important matters. The weekly survey includes questions on personal finances, job security, the economy and real estate. In October, only real estate had more optimistic responses than pessimistic ones.
That’s a testimony to the strength of Canada’s housing market in 2020. Despite widespread damage in most economic sectors, the housing market has been surprisingly resilient. However, these gains could cause serious problems down the line.
What could happen if the bubble pops
The more expensive houses get, the larger the mortgages needed to buy them. This factor can lead to serious problems in the event of a housing market crash. If you borrow $500,000 to buy a house and then lose your job, you still have to pay the money back. If you don’t, the bank can go after your assets.
That’s a bad enough situation, even with a strong housing market. If the housing market tanks, it’s even worse. In that situation, after the bank forecloses on your house, you’ll have to pay them the money remaining on the mortgage. So, if you owed $500,000 on a mortgage, and the house declined to $250,000 in value, you could end up owing $250,000.
How to stay safe
One way to keep yourself safe from a housing market crash is to diversify into assets other than real estate. The more baskets you spread your eggs across, the lesser your risk. That works in your favour if one of your assets — such as a house — collapses in value.
Let’s imagine that you had $250,000 in a house and $250,000 in an ETF like the iShares S&P/TSX Capped Composite Index Fund (TSX: XIC). XIC is an index fund with a 2.9% yield. That means that you get $7,250 in cash back each year from dividends on a $250,000 position. If you realized a 5.1% capital gain on top of the dividends, you’d be up 8% in total. That would more than offset a 5% decline in the value of your house. On the other hand, if you owned a $500,000 house and had no other assets, you’d be in much worse shape. In that situation, if the house lost 5% of its value, you’d simply be down $25,000 in net worth with nothing else to make up the difference.
As the example above shows, diversification can help protect your net worth when one of your assets loses value. Whether you ultimately go with stocks, bonds, or GICs, anything is better than having every penny of your net worth tied up in your home.
