Should you invest in Canadian real estate?

At current prices, real estate as a pure investment may not make sense, says John Pasalis of Realosophy, especially overpriced pre-construction condos.

Ruth Saldanha 5 November, 2018 | 6:00PM

Last month, real estate firm Royal LePage released its House Price Survey and Market Survey Forecast that showed that year-over-year home prices made modest gains in many regions across Canada in the third quarter of 2018, with some markets even declining.

The Greater Toronto Area (GTA) saw an overall decline of 0.4% in home prices year-over-year. The Greater Montreal Area saw a 5.4% increase in aggregate home prices, while Greater Vancouver saw an increase of 3.9%.

Over the long term, real estate is considered a great investment, and for many investors, a home forms the single largest asset they own. So at these prices, does real estate as an investment make sense?

Not really, says John Pasalis, president of Realosophy.

"There are two components that we're looking at. The first is the cash flow and the return we're getting from rent. And then the other side is capital appreciation. Right now, house prices are so high, rents are not high enough to cover the carrying cost of the property. So investors would need to put 50% to 60% as a down payment to at least break even," Pasalis says.

In areas with high home values, like Greater Vancouver and the GTA, a 20% down payment often equates to more than $160,000, or roughly the same price as a home in Moncton, New Brunswick, according to Royal LePage.

"People have been putting a lot of money into real estate just because of the belief that the prices would keep going up. But now, most people are thinking that the growth in house prices is going to slow down a lot over the next year, especially as interest rates are going up. Maybe it's good long-term, but short-term I think prices are still too high to be investing in," Pasalis noted.

Another challenge is that prices have risen rapidly. Scott Evans, financial advisor at Blueshore Financial, points out that in markets like Vancouver, homebuyers often find they "can't save fast enough," as prices rise quicker than savings abilities.

In the past five years, on average, home prices in Canada have increased by 45.1%. In Greater Vancouver, prices are up 76.8%, while Greater Toronto prices are up 60.6%. Greater Montreal is up 15.5%, according to the Canadian Real Estate Association.

To safeguard against this, some investors look to put money into pre-construction condos, believing they can get a better price for more square footage. But this is not a sound idea, according to Pasalis.

"Pre-construction condos are a purely speculative bet," Pasalis says, noting that the challenge with pre-construction condos is that the prices that investors are paying today are anywhere from 20% to 30% more than resale prices. Which means investors believe prices will grow 10-15% per year in order for them to make a profit from that investment, he notes.

"The concern I have is that the mindset of pre-construction condo investors is disconnected from the reality we are seeing on the resale side. On the resale side, people can't afford their payments, they are turning to private lenders because they can't control costs, they are overburdened debt-wise. The resale market has cooled down, but pre-construction [buyers] think that prices will go up 10% to 15% per year. I don’t see that level of growth," Pasalis warns.

For investors who do want to invest, are there any pockets that still hold value?

"If you’re investing for the long term, if your plan is 15 to 20 years, if you buy smaller multi-unit residential properties, 3-6 units, or even as many as 10 units, those will cash better, and have better stability and cap rates," Pasalis says, adding that lots of people have invested in single-family homes, which are not the best investment right now.

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Ruth Saldanha  Ruth Saldanha is Senior Editor at Morningstar.ca