Tuesday, July 19, 2011

Do Real Estate Values Always Go UP?

I would normally address multi-family real estate, but I think it's a good time to discuss single family homes and how they are affected by the market as are all other investment types.  Let's get to the details!

It's interesting when you talk to different people how you can get "opinions" on just about anything.  I prefer to live my life with facts after listening to opinions and then making an intelligent choice.  As some of you may already know, I have an engineering background, so I'm a numbers guy.  I like numbers and I like charts.  When you have real, correct information, charts don't lie.  They tell you exactly what happened and when applied to real life, they can help you determine what may happen in the future.  This isn't 100% accurate, but it sure can give you clues to what may happen.  Take a look at the charts below showing average home prices for Toronto, ON from 1980 - 2010 (not inflation adjusted), and one showing same for the USA as a whole (courtesy of Toronto Real Estate Board and

You will notice there are long periods of price appreciation in both.  In Toronto, prices were flat from about 1981 to 1985 and then started climbing steeply. I like to visualize things, so let's picture a hill, and you're driving up the hill with a bike. As the hill gets steeper, prices act the same way as gravity pulling on your bike in our example.  The steeper the hill gets, the harder you have to pedal, and eventually, you reach the top, "you're now tired", and then you start going downhill.  Prices behave the same way and that's exactly what happened in 1989 with Toronto home sales average selling prices.  Notice that prices fell like a rock and the average sales price fell from about $275,000 in 1989 to roughly $200,000 nearly 7 years later!  Since then, prices have been appreciating again, and notice that the most recent push upwards is much steeper from 2009-2010 than it was years earlier.  What is this telling us?  It tells us that at the moment prices will likely continue to rise, however we need to be careful when entering such a market.  It doesn't mean we shouldn't, it just means we need to be careful depending on what our financial goals are for the future.   Low interest rates attract buyers, however should interest rates climb (which nearly every major bank that I know of is stating is on the short term radar), then those monthly payments that people find affordable now, will become less affordable with higher rates.  This upward trend in interest rates would put pressure on a reduction in prices.  This is not to say altogether that one shouldn't buy in the Toronto market, just to say, "watch out and be careful with your decisions".

Now let's look at the USA market.  A similar trend occurs except only a slight pullback around 1989 and then the crash starting around mid-2006 with some stabilization since 2009.  It is not clear whether prices will continue to fall further before rebounding, however they are approaching a 30 year inflation adjusted low.  Notice the red line which is inflation adjusted.  This line shows us that the average home price in the USA was around $150,000 in 1980 and 30 years later it is $162,000.  If one bought a house in 1980 we would have only seen a marginal increase in our investment when inflation was taken into account.  If you factor in mortgage payments, property taxes, utilities, there is a net loss in equity over that time period.  Please remember that these are only averages we are looking at, but they do paint a picture quite well.  Which market looks like it may be a better "buy" right now?  A house in the USA or one in Toronto?  USA average home prices are near 30 year lows now.  Again, the choice is yours and clearly every local market has it's own pluses and minuses, so there is more involved than just looking at a couple of charts, but do you see how this can help you in determining where you are in the market cycle depending on your community? 

We've shown that real estate does not always go up.  Prices are affected by the market and the market is driven by emotion, perceived value and supply & demand.  If someone is willing to pay you a certain amount, you'll get it; if they're not, you won't.  That's the beauty of the market and it can also be like falling on a knife when it works against you.

So here's the deal:  Real Estate behaves exactly like the stock market or any market for that matter.  It goes up and it goes down because of various and sometimes differing market forces.  The difference is that the periods of up and down price movement is over a much longer period of time typically for real estate compared to the stock market.  We have zero control over the market.  So what's the key?  Well, it's buy low and sell high of course, however it's not as simple as just buying with the "hope" that your property will be worth more next year.  This is a gambler's approach.  Let's look a little further now and see how real estate mimics the stock market as well.   

Look at the price chart for the S&P 500 (courtesy of below (Black chart).  Flat pricing from about 1963 to 1980 and then value took off and kept rising until about 2000 (dot com bubble), and then lost value for three years.  Value rose again until we see the same highs reached from 2000 in 2007 and then the recession took hold, reducing values again to the lows seen in 2002.  

Now, we are in a short term bull market again with values rising and approaching all time highs we saw in 2000 and again in 2007.  What do you think might be a good idea should values rise again to all time record values?  Only you can decide that but I know that I would be very wary of buying "at the top" and expecting a long term gain.

So what have we learned?  We can use our wits and make intelligent choices of when to buy and sell rather than just jumping in and following the herd.  When the media say buy, buy, buy, you may want to decide to look further into the numbers and perhaps do the opposite.  Educate yourself and then make intelligent choices.  Buy and hold works for anything including real estate, but you have to be on the right side of the market to make money.  Remember, this is buy low and sell high (or in stocks it could be both buy low/sell high or sell high/buy low with the latter called "shorting").  Unfortunately, we can't short real estate like we can stocks!  Blindly following others is not a good way to invest your hard earned money.  Listening to gurus and so called experts can also get you into trouble if you blindly do what they say.  For those of you considering buying or selling real estate of any kind, bear those ideas in mind before making your next buying and/or selling decision.

I hope you enjoyed this article and that what you have read here will help you in your future investment choices, whether that's real estate or whatever else that may be.

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