The Motley Fool

Warning: The Housing Bubble Could Get Worse

Image source: Getty Images.

There’s no denying it; Canada is facing a housing bubble. Real estate prices have skyrocketed in recent months, as end users and investors rush out to grab bargains created by the crisis last year. 

If you’re renting or on the sidelines, the barrier to entry is about to surge much higher. Here’s what you need to know about Canada’s housing bubble, its impact on the economy, and the stocks you should buy to gain exposure. 

Housing bubble

In Toronto, the average selling price for all home types was up 14.9% to $1,045,488. Homes in other major cities, from Montreal to Vancouver, were similarly up by double digits. 

However, a double-digit surge in prices doesn’t mean a market is in a “bubble.” A bubble is better defined based on fundamentals. In the case of housing, the fundamentals are income and rents. Essentially, the price-to-rent and price-to-household income ratios are the key metrics to watch. 

Last year’s crisis pushed household income and rents much lower. That means this recent rise in prices is a clear indication of a bubble. The government can step in and prevent it by adding taxes or discouraging speculation. But they won’t. Here’s why. 

Canada’s fragile economy

Housing is, by far, the biggest component of Canada’s economy. In the third quarter of 2020, investment in residential real estate accounted for 9.43% of Gross Domestic Product (GDP). That’s a historical high for Canada and higher than any other developed nation of a similar scale. 

In short, Canada’s economy is overdependent on real estate, which is why the government is committed to keeping prices up, even if that means a housing bubble. This morning, former Bank of Canada Governor Stephen Poloz said, “We cut interest rates in order to boost the economy … If the side-effect is a hot housing market, that’s one I’ll take every day.”

How to prepare

If you’re a homeowner, congratulations on the future windfall. But if you’re an investor, you may want to take a longer-term approach. The ongoing housing bubble, like all other bubbles, must eventually end. Either income and rents need to climb, or prices need to drop in the future. 

Rising rents should benefit real estate investment trusts (REITs) such as Canadian Apartment Properties REIT (TSX:CAR.UN). CAPREIT has a diversified portfolio of residential units across the country. According to its latest filing, occupancy was 98.2%, and the average monthly rent for its portfolio was $1,084.

Meanwhile, the stock is trading at 16.5 times future cash flow per share and 99% of book value. That means the valuation is suppressed at the moment. The ongoing housing bubble should expand CAPREIT’s book value. If you believe rents will rise soon, the company’s cash flow should improve, too. 

Basically, this is a great buy if you believe a housing bubble is inevitable. And all evidence seems to suggest it is. 

Bottom line

A housing bubble in Canada seems clearly evident. Bet on the winners: residential REITs.  

Looking for more quality stocks? Here's a list.

The 10 Best Stocks to Buy This Month

Renowned Canadian investor Iain Butler just named 10 stocks for Canadians to buy TODAY. So if you’re tired of reading about other people getting rich in the stock market, this might be a good day for you.
Because Motley Fool Canada is offering a full 65% off the list price of their top stock-picking service, plus a complete membership fee back guarantee on what you pay for the service. Simply click here to discover how you can take advantage of this.

Click Here to Learn More Today!

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 Vishesh Raisinghani has no position in any of the stocks mentioned.

Two New Stock Picks Every Month!

Not to alarm you, but you’re about to miss an important event.

Iain Butler and the Stock Advisor Canada team only publish their new “buy alerts” twice a month, and only to an exclusively small group.

This is your chance to get in early on what could prove to be very special investment advice.

Enter your email address below to get started now, and join the other thousands of Canadians who have already signed up for their chance to get the market-beating advice from Stock Advisor Canada.