Regulators to probe impact of foreign money on real estate; Reader question- What to do with real estate windfall...
JUNE 05, 2011
It’s been an interesting week. Greece faces a near-certain default of some form in the not too distant future, though reports indicate that a new bailout is in the works. Hopefully this one has a longer half life than the last. And of course the Euro zone bankers are sleeping a little less soundly now that Greece teeters on the brink and new signs of weakness are emerging out of too-big-to-bail-out Spain. A haircut on Greek bonds held by the large Euro banks will certainly ratchet up credit market tensions and risk a second financial crisis. How this will all play out will be the story of 2011 and 2012, though expect the rot to continue unabated and begin spreading from the Eurozone periphery PIIGS nations to the core, testing the will and resolve of the monetary union.
Meanwhile jobs and manufacturing numbers disappoint in the US. In fact, manufacturing is slowing the world over. The stock market is showing signs of stress as investors are increasingly anxious about the looming end of QE2, with risk assets coming under expected pressure while bonds find their bid. Rising bond prices have pushed yields lower this week. This is all good for interest rates as the big banks have started slashing their 5 year posted rate. As I’ve said all along, the bond markets, which are nearly 15 times larger than the stock markets in North America, are far more fearful of deflation at this point than runaway inflation. Deflation is the economic version of the Bogey Man. It’s what keeps central bankers awake at night. The risk of deflationary pressures remain far higher than most realize, despite the speculator led run-up of oil prices.
But alas Canada is an island....insulated from the global storms that buffet other nations. At least that’s what we seem to believe. The Toronto market has found its mojo. You’ll recall that for the past two months I have been warning that if inventory levels don’t normalize, we’ll see the return of bidding wars by the Summer. It looks like that may well be the case as house prices and sales have surged in May.
Meanwhile on the wet coast, giddy buyers happily snap up tear down houses on 50 foot wide lots for 2 mil. Remember, a couple million is a bargain compared to the prices found in other major global cities where incomes are twice that of Vancouver and where there is a real, functioning economy. But there’s a risk that some of these international buyers who find Vancouver’s pricy real estate so sexy might actually pull out a calculator, look just south of the border at a very similar city in Washington state, and realize that they can buy a home for a third of the price and with much better long-term prospects for capital appreciation. What happens then? And far more importantly, what happens to the pie-in-the-sky story that has captivated BCs population and led them to believe that millions in debt is alright as there will always be a dumber, wealthier foreign buyer willing to take it off their hands for more than they paid? This is the great risk and this dynamic, more than the actual buying by wealthy foreigners, that has driven BC real estate to such ridiculous heights. What happens when the effects of the kool-aid wears off?
Well, sales and prices will fall.....hard. At least that’s the concern of the country’s chief financial regulator who is now looking into the impact of foreign capital on real estate markets in Canada:
Canada’s top banking regulator is on a fact-finding mission to gauge the scope of foreign investment in residential real estate.
Industry sources say the Office of the Superintendent of Financial Institutions is sizing up the market, most likely as part of its active campaign to “stress-test” the country’s big banks to measure how they would be affected by volatility in various market segments.
OSFI is taking a broad look at bank exposure to household debt and how the financial institutions are monitoring loan portfolios amid growing concerns over the ability of Canadians to handle their debt load.
In the case of the housing market, sources point to global trends that could affect investment in Canada — such as China’s recent policies to curb speculative real estate investment in that country — as evidence that Canada is operating in a fast-changing market that could be adversely affected by decisions made in other countries.
They suggest OSFI wants to know how big a factor foreign investment in Canada’s housing market is, and how big it is likely to become, so the regulator can measure the potential impact on banks if demand were to dry up.
If the trend of international investment were to continue indefinitely, it would not be a troubling issue for the country’s banks. The problems would come if transient foreign interest were to contribute to the formation of a real estate bubble.
“If demand for residential real estate were to dry up in Canada, it would not be good for Canadian banks...”
It would be great to finally have some real insight (beyond the anecdotes from the real estate industry) into the prevalence of this purported driver of real estate prices. I doubt that it will lead to any significant regulatory changes. I don’t think it really should. Taxpayer exposure to foreign speculation is very minor as CMHC limits mortgage guarantees for non-permanent residents to one owner-occupied dwelling and requires a 10% down payment. I think if we could see the balance sheets of those buying, we’d find that overwhelmingly they are Canadian citizens with terrible balance sheets just like the rest of us. The fact that BC debt to income ratio for all residents is by far the highest in the country certainly argues against the silly notion that real estate prices are being driven by loads of foreigners purchasing property with bags of cash. That simply doesn’t compute.
The reality is that time will solve this issue. Speculators will be slaughtered and those who jumped in on the advice of the real estate industry will quickly learn the term ‘caveat emptor’. But not all have drank that kool-aid.
Meet ‘J’. Her and her husband recently sold their Vancouver home and now sit on an enviable cash pile of some 800 large. What to do with the windfall?
My husband and I have decided to stay out of the housing market in Vancouver for a while. We are not willing to invest more than a million dollars (including a mortgage) in a home that needs renovation or is in some other way not what we want to live in. We are hopeful that in 18 months to 3 years the housing market will correct enough so that we can more comfortably afford what we want.
My question for you is what should we do with our house equity?
We have about $800,000 that we need to park somewhere. This money is ear-marked for our home and not tied to retirement investments.
We want low risk but still want to earn something, ideally about 8% if this is a reasonable expectation. We have considered carving off some of this money to invest more aggressively. With the markets so volatile right now and our investment horizon relatively short we don't know the best course of action.
We have consulted a couple professionals but I wanted to include your advice, and any ideas your readers may generate, in our research.
So far we are considering:
33% cashable GIC's/High interest savings account (OK with locked-in for 1 year but not more), 33% corporate bonds (not Mutual fund bonds)
33% stocks/equity/shares (stocks/equity/shares to be blue chip and posses a low MER. (Avoiding emerging market funds as well)
Would maximize 2 TFSA within this.
Well, I stand by my advice from this post. I’ll let my knowledgeable readers chime in first before responding in the comment section.