The last 15 months saw several bubbles burst, starting with the tech bubble at the start of 2022, with the crypto bubble following suit. The rising interest rate caused the bubble to burst. The most recent bubble is of U.S. banks. Rising interest rates reduced the value of bonds held by banks, causing a liquidity crunch when customer deposits surged. The popping of bubbles one after the other has raised concerns if Canada’s property bubble next.
Some industry experts say it has already popped; some say it will pop soon. Let’s look at the Canadian real estate market and understand whether it is a viable investment option.
Canada’s property bubble
A bubble forms when an asset price inflates rapidly beyond its value. But there comes a point when the price becomes unaffordable and comes crashing down. That is where the bubble pops. There are five stages of a bubble: displacement, boom, euphoria, profit taking, and panic.
Canada’s property bubble started inflating, as the Bank of Canada maintained a low interest rate (0.25-1.75%) in the 2020 decade. Canada’s housing prices reached the euphoria stage in 2021, with the Canadian Real Estate Association (CREA) House Price Index rising at its fastest pace of 26.6% year over year in December 2021. The stimulus money and record-low interest rates inflated the bubble. House prices rose to a point where they became highly unaffordable, with the average home price at $713,500 in December 2021.
The financial environment reversed in 2022, as the central bank hiked interest rates from 0.25% in February 2022 to 4.5% in March 2023. Inflation reduced the value of money, and high-interest rates reduced the money in the hands of consumers, slowing demand.
Canada’s housing prices dropped 15.8% year over year in February 2023, raising concerns that Canada’s real estate bubble could pop anytime. The house price has to drop another 20-25% to reach the affordability level. The current macro environment could pop the property bubble if things worsen.
How to prepare for a Canadian property bubble
The thing with bubbles is you know you are in one but don’t know when it will pop. While you can’t time a bubble, you can prepare your portfolio for a bubble. The interest rate hike has reduced the fair market value of properties, pulling down prices of all real estate investment trusts (REITs) trading on the TSX. BMO Equal Weight REITs Index ETF fell 22% from its March 2022 high. A gradual decline shows profit taking by value investors. If the property bubble pops, the exchange-traded fund could fall by double digits again.
But unlike technology or oil stocks, real estate is an asset whose value appreciates. Many economists expect property prices to return to growth in 2024, as the macro environment recovers. You can use the market bearishness to buy into high-quality REITs and lock in high distribution yield and a chance at capital appreciation.
CT REIT
The retail giant Canadian Tire (TSX:CTC.A) spun off its real estate operations to CT REIT (TSX:CRT.UN). The REIT earns 91.5% of the rent from Canadian Tire, which removes the risk of a lower occupancy rate and secures its distribution per share from rental income. However, the REIT is exposed to concentration risk, as its distribution depends heavily on the performance of Canadian Tire.
Canadian Tire has a 23-year history of paying regular dividends. It has recovered from all the economic crises and bubbles since 2000. The parent’s strong performance builds confidence in the CT REIT. The REIT’s stock price surged 67% in the 2021 bubble to over $18. It is now trading 13.5% below its peak and has the potential to reach the peak and even surpass it as the economy recovers.
You can invest $250 monthly in CT REIT stock and another $250 in the ZRE ETF throughout 2023. If the property bubble pops, you can buy the dip. If it doesn’t pop, you can reduce your overall cost through dollar cost averaging. In both scenarios, you can book your spot in the recovery rally.
Final thoughts
While investing in REITs, also invest in other sectors like tech and banks that will benefit from a recovery. A diversified portfolio can reduce your downside.
