work required was beyond her and the secluded location of the house on a large plot of land made her nervous about security. She knew that because of the size of the property it would take a long time to sell so she decided to buy a condo in the centre of the city. When she applied for a mortgage to buy the condo she was turned down. It turned out she had co-signed a loan for one of her children to buy a home one year earlier. The bank wasn’t prepared to lend her any more money as she was retired and a widow. When she told me the story, after the fact, I realized that real estate exposure might extend beyond the properties that I knew about. I had no idea she had co-signed on a mortgage for one of her children.
I began asking my clients about how much help they’d given children and grandchildren to buy into the housing market. To my surprise, parental help was more widespread than I would have guessed. Sometimes it was a gift of cash for a down payment (preferable), or a loan (not bad); it could be co-signing a loan at a bank (horrible idea). Of course the banks love to get a second signature as a personal guarantee from a wealthy parent or grandparent and it seems like a small thing that a parent could do in order to get a discount on the interest rate. This phenomenon of providing financial help to offspring to get them into the real estate market as soon as possible is so widespread that a name has been coined: the Bank of Mom and Dad.
I really started to worry as I learned more about the large amounts of money involved. The alarm bells were ringing loudly, at least for me, even before we witnessed the crash in the U.S. What if the real estate market crashed? If my clients kept buying more real estate instead of investing in a balanced portfolio of stocks and bonds diversified over different sectors and different countries, their ability to fund their retirements would be limited or, in an extreme scenario, their retirement could be ruined. All of the good work done over many decades through careful savings and investing could be overwhelmed by a series of bad decisions in the real estate market – a market that is very illiquid by nature. Mistakes can be difficult or impossible to unwind. I noticed, too, that my powers of persuasion failed completely when it came to my clients’ new love affair with real estate.
Apparently what had happened, which is clear in hindsight, is that people had become frightened by the demonstrated volatility of the stock market and a perception of elevated risk, and became more comfortable with the “stability” of the real estate market. A steady growth rate of a few percent per year attracted them when compared to the 50 percent or greater drop in the stock market. After all, if a stock like Nortel can collapse, the stock market must be a very risky place. So people opted for the tangible investment, the house and the condo and the rental property. Even though my clients hadn’t experienced anything like a 50 percent drop in market values in their personal portfolios, the news media reported the stock market disasters and the general feeling of unease had seeped into their consciousness at a deep level and made a lasting impact.
I had, with skill and some luck, managed to steer my clients through the dot-com bubble in stocks. Retirement plans were intact and investment values had grown. But what if all that work were reversed in a real estate crash? I worried about what would happen to my clients in the event that real estate prices stopped going up or started to slide. The benefits of having a balanced portfolio of investments providing the ultimate in safety and return was in jeopardy because of a gross misallocation of savings into one asset class: real estate.
And then the even bigger shock occurred. The United States real estate market crashed and the world went through a financial crisis like nothing that had happened in my career. Again my clients survived the stock market crash with relatively little losses. The Canadian economy suffered a mild recession and real estate values dropped a bit, but nothing like the 40 percent declines in the U.S.
To my complete surprise Canadians continued in their love affair with real estate, even after witnessing the value destruction and devastating losses that hit so many in the U.S. housing market. I couldn’t imagine that the global financial crisis, referring to the 2008–09 period and known as the GFC, wouldn’t have a profound effect on Canadian investors and their attitude toward risk. But I was wrong.
The Buy-High Trap of This Decade: Canadian Real Estate
While this was happening with the real estate market and the associated financial crisis I had been playing with a book idea to inform Canadians of the buying opportunities in the stock market that would come after the period of deleveraging (paying down debt) ends. I believed that the deleveraging cycle that had started in the United States after the 2008–09 financial crisis must run its course before one can confidently say that there is a new bull market for stocks. That deleveraging cycle has yet to start in Canada.
The book that I started to write was based on my observation that some investors tend to get caught in a buy high, sell low trap that means they will buy at high points like the dot-com bubble in 1999 and sell out of their investment at low points such as the one in 2009 or the one that I believe is coming in the middle of this decade.
Ideally investors should try to take advantage of the bottoming of the cycle when the public is selling stocks at extremely low prices. Investors who are prepared could scoop up the bargains that always appear in the down part of the cycle, near the bottom. But they might be held back by fear, as many were in March 2009. Or they could be unable to take advantage of the buying opportunity because they don’t have any liquidity or money that is not tied up in other investments.
It would be a very unfortunate experience if one had overcome one’s fear and was ready to buy at the right point in the cycle only to be thwarted by a lack of liquid financial resources. Or worse, what if investors needed cash to shore up their illiquid real estate holdings and used the easy liquidity provided by their diversified portfolio of investments to meet their debt obligations? This happens in every market cycle when the best investments sell, because there is a willing buyer, but the worst cannot be disposed of because there is no buyer and no liquidity. That’s when the penny dropped for me. What if this buying opportunity arrives soon, in the next year or so, but my clients have so much money in illiquid real estate that they are unable to take advantage of the opportunity? Or worse, they sell their good investments held with me to prop up their bad investments elsewhere? Nightmare!
I realized that before I get ready to talk to people about the buy-low opportunity in the stock market that will arrive eventually in Canada, there had to be a discussion about the housing bubble and what that means for the many owners and investors who are exposed to excessive debt levels backed by overvalued real estate with little idea of the risk involved.
The possibility that my clients would miss out on a significant stock market buying opportunity caused me some sleepless nights. The idea for this book came out of that imperative: to reach enough people before they were caught in the wrong asset class — real estate — and unable to sell, just at precisely the time when an amazing array of financially sound investments would become available.
A bull market in the stock market represents the chance to make gains that are many multiples of the original investment. For example, the bull market that began in the United States in 1982 ended in 2000 when the index had risen fifteen fold. Not 15 percent, but fifteen times the original investment! So an average amount of money used to buy a modest house or condo in Toronto or Calgary, say $500,000, would grow to be worth about $7.5 million. And that’s just the average return for the stock market during that bull market — there would be some that did substantially better. Can you imagine a six-hundred-square-foot condo in a Toronto high-rise being worth $7.5 million in eighteen years? I agree, it’s not going to happen.
My goal with this book is to alert as many people as possible to the fact that Canada is in a housing bubble and it’s a buy-high trap similar to the dot-com bubble of 1999. If investors want to be successful in the next bull market cycle, it’s essential that they make some adjustments now so that they can protect their retirement assets and prepare their personal finances to insulate themselves against the inevitable deflation of housing values. Canadians must take steps to protect their
