Canadian investors may be more exposed to a housing correction than they think.
In addition to direct home ownership, falling prices could reach Canadian portfolios through a variety of channels, none more popular right now than bank stocks.
With the Bank of Canada raising new fears about the national housing market, personal holdings of real estate and financial securities can compound the level of housing risk contained in a portfolio.
"Canadians should be thinking about how much exposure they have," said Ben Rabidoux, a Canadian housing market analyst. "I would argue that Canadians are massively overexposed via the financials."
On Wednesday, the Bank of Canada highlighted the hot housing market as one of the country's biggest economic risks, estimating the overvaluation for the first time at up to 30 per cent.
The warning adds weight to the persistent concerns of housing bears, who have long argued that Canada is at risk of a painful pullback to which both homeowners and investors are vulnerable.
The post-recession housing boom in Canada, fuelled by historically low lending rates, has elevated household debt levels to near-record levels, while supporting ever-rising prices.
In October, the average home price in Canada came in just shy of $420,000, up by 7.1 per cent from October, 2013.
Kurt Rosentreter, a financial adviser at Manulife Securities, said it's not uncommon to encounter clients with 80 per cent of their net worth tied up in their homes. "That could really hurt you if real estate drops and interest rates rise," he said.
On top of that, Canadian investors tend to take on additional real estate exposure through portfolio securities.
Investing in housing through the stock market can be done through residential real estate investment trusts, mortgage investment corporations, alternative lenders' stocks and the like, all of which are likely to decline in proportion to a housing market selloff, Mr. Rosentreter said.
Of far greater concern is the prevalence of Canadian bank exposure, Mr. Rabidoux said. "Canadians have a love affair with the banks."
The Canadian banks have been on a near-uninterrupted run since the recession, realizing soaring profits as Canadian households continued to borrow and spend.
As a result, bank stocks have gone on a tear. In the past three years, for example, Royal Bank of Canada, the largest company on the Toronto Stock Exchange by market capitalization, nearly doubled in share price prior to the selloff of the past two weeks.
But a housing correction could ripple through the Canadian financial sector, Mr. Rabidoux said. Slowing demand for mortgages and other loans would negatively affect profit growth.
"There are so many ways the banks would get hit, when you start to consider the degree to which the Canadian economy is levered off of housing, renovations and construction," he said.
In some ways, the big banks are difficult to get away from in Canada. The financial sector now accounts for around 36 per cent of the market capitalization of the S&P/TSX composite index, so investing in a broad index fund or ETF would include a sizable dose of bank exposure.
Plus, convincing Canadian investors to reduce their bank holdings is a challenge, such is the extent of positive sentiment toward a class of stocks that has consistently elevated investor returns, Mr. Rosentreter said.
"Don't get greedy with bank stocks. You need a diversified asset mix and bank stocks should not be 40 per cent of your portfolio."
Even those convinced of the resiliency of the real estate market should avoid overexposure in the interest of basic diversification, Mr. Rosentreter said.
"You have a lot of money in your home, that's already more than enough in Canadian real estate."
Tim Shufelt