Can millennials afford to rely on their home as a retirement plan?

Price, location, affordability all come into play as younger investors delay or revisit expectations of first home ownership.

Ruth Saldanha 22 October, 2018 | 5:00PM

For many people, the single largest asset they will own in their lifetime is their home. As a result, the home often becomes a key component of retirement plans, with many soon-to-be retirees considering downsizing homes to fund retirement.

"Traditionally, many older adults have considered home equity as part of their estate plans; their homes are where they live, of course, but they're also an asset that they would pass to their children or grandchildren after they're gone," says Morningstar's director of personal finance Christine Benz.

But with the high cost of home ownership in Canada right now, can millennial investors even afford to buy a home right now? And for those young people who are able to become homeowners, will residential real estate appreciate enough to allow them to tap into their home equity in retirement?

Affordability an issue in some markets

Last month, RBC Economic research released its Housing Trends and Affordability Report, that said that affordability has not been this bad since 1990 and said that unaffordability is off the charts in Vancouver, Toronto and Victoria.

"In markets like Toronto or Vancouver, affordability is a barrier to entry for younger investors, however in other markets like New Brunswick, rural Quebec or Saskatchewan, affordability is higher," said Robert Hogue, senior economist at RBC.

As a result, many new and first-time homebuyers in overvalued markets are being priced out, meaning many younger investors are unable to purchase, or are delaying purchase of what could likely be the single largest asset they would own.

According to real estate firm Royal LePage, peak millennials -- those born between 1987 and 1998 -- usually have a maximum individual home-buying budget of $203,246, factoring in a 20% down payment as well as new rules introduced by the Office of the Superintendent of Financial Institutions in January 2018.

So, in order to afford a home, millennials have to save, pool money with a partner (thus doubling the budget to $406,479) and/or borrow funds from their parents, many of whom are downsizing in retirement and can financially contribute to their child's first home purchase.

For those who can afford it, though, real estate is universally considered a good investment in the long term.

Over the long term, residential real estate is a great way to build long-term wealth and have a family home, says Robert Hunger, vice president and managing director of BMO Nesbitt Burns. However, he cautions that it is imperative that new and first-time home owners buy a home with eyes open, pointing out that there are several other costs to home ownership, both onetime costs like down payments and closing costs, as well as ongoing and recurring costs including taxes, maintenance and home repairs.

Once you manage to buy a home, will the growth keep up?

Growth outlook

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%.

These numbers look great, but is this level of growth likely to continue? Though long-term growth is certain, experts believe that in the short to medium term, growth is unlikely to continue in the same way as it has over the recent past.

In the past decade or so, there has been an unusual situation where inflation has been low and home prices have risen significantly, but this is unsustainable in the long term, said Phil Soper, CEO of Royal LePage. Already, interest rates are rising, and inflation is expected to rise as well, which will eat into home price returns.

"Valuations and affordability are stretched in Toronto, the GTA and Vancouver, and mortgage rates are unlikely to trend down as occurred in the past 15 years. Mortgage qualifying rules are also tougher now, and the B.C. and Ontario governments have imposed measures to cool the market, notably with a tax on non-resident buyers. Home prices are likely to run no faster than family incomes, though they will be supported by limited supply and strong demographic demand," says BMO senior economist Sal Guatieri.

Having said that, real estate is an extremely localized market, and there definitely are some pockets that would make sense for investors looking to buy.

Where can investors buy?

Though prices, expenses and entry barriers are the highest in Vancouver and the GTA, paradoxically, these regions are expected to have the highest returns going ahead, Soper said.

Another market that could see upside is Calgary, Soper said, pointing to the region as an obvious example of a real estate market on the cusp of breaking out again. The prices in Calgary have seen a correction, but the region also has strong fundamentals, including a young population, higher incomes and a recovery in oil prices, which would make residential real estate in the area a good bet, he noted.

Finally, for families looking for affordable housing to raise a family, Atlantic Canada would make sense, where there are some great bargains to be had, but not too much upside, Soper noted. "Halifax is the best bet for residential real estate in this region," he said.

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