By: Jeff Pollock
April 13, 2017

A stunning 54% of respondents to a CIBC poll published last week said that they believe Canadian home prices will never fall. These presumable homeowners are falling victim to a classic cognitive shortcoming called the “recency bias.” This occurs when there is a wrongful assertion that trends and patterns recently observed will continue to replicate into the future. After Toronto recorded a 33% price soar in its housing market year-over-year this past March, many are expecting these unsustainable gains to continue into perpetuity.

Several intuitive reasons have helped fuel prices higher. Yesterday, the Bank of Canada’s Governor, Stephen Poloz, attributed Toronto’s housing appreciation to immigration and economic growth. Beyond that, several additional factors have impacted the market. First, the provincial greenbelt surrounding the Golden Horseshoe has restricted land development to build new homes. Second, low interest rates have made home ownership (and additional investment property) more affordable. Third, the Canadian loonie – which has depreciated by over 25% the past half decade when it traded at par with the US dollar – has attracted foreign buyers. Last, the psychological fear by domestic residents of being priced out of the market along with their dreams of homeownership foregone is surely weighing on purchasing decisions.

Despite the opinion of those 54% of poll respondents, however, housing prices can go down.

From 1989 to 1993, the nominal price of a Toronto home dropped by almost 25% from $274,000 to $207,000. In the five years prior, prices increased by almost 170% from $102,000 to $273,000. It would take over a decade before nominal prices finally surpassed their 1989 level. With the benefit of hindsight being twenty-twenty, the rapid growth in home prices for much of the 1980s has largely been ascribed to investment speculation that prices would rise indefinitely.

We’re starting to see several trends from the 1980s recur. According to National Bank economic Marc Pinsonneault, a correlation can be found between Toronto’s home price appreciation and the US housing market from the mid-2000’s before it corrected downwards. Furthermore, the 2016 Census found that the Greater Toronto Area may have 99,236 unoccupied homes. This represents 4.5% of the total housing supply in the region, but is 10.5% higher when compared to the number of unoccupied homes 5 years ago. Toronto Mayor John Tory has even mused about implementing a vacancy tax on Toronto’s 65,000 potentially vacant homes.

While Toronto’s rate of housing price appreciation is not sustainable, its residents clearly must live somewhere. The benefits that accompany a tax-exempt principal residence, not to mention the rental expenses that need not be paid to a landlord, offer good reasons to own a home. However, investors looking to buy additional property for investment purposes should think twice about this kind of a decision. Instead, diversification across multiple asset classes to include not just real estate but also blue chip, dividend-paying equities (and fixed income securities depending on the income it accompanies) that are exposed to geographies besides Toronto is essential to mitigate investment risk.

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