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Dan Richards

Appreciate your house, but don't expect it to appreciate a lot Add to ...

Recently, the real estate industry has dominated the headlines.

Mark Carney, Governor of the Bank of Canada, raised warning flags about the impact of higher interest rates on those Canadians who are already stretching to carry their mortgages.

There's been coverage of the dispute between the Competition Bureau and the real estate industry over proposals that would allow greater price competition among real estate agents.

And there have been suggestions from within the industry that there needs to be increased professionalism among real estate agents.

For many Canadians, none of these is the central issue when it comes to real estate. Rather, the key question comes down to the appreciation they can expect on the investment in their home.

After all, the past decade has been a great period for homeowners. Expecting this to continue, some Canadians have stretched to buy larger houses now, before prices get away from them. Research firm Investor Economics points out that residential mortgages are at a record level, approaching $1-trillion.

Investor Education:

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  • What makes buying a home different from other investments?
  • What are some renovations that add value to my home?

The lessons of history

I had a conversation with Royal LePage president Phil Soper about the kinds of returns Canadians can expect on their houses.

His central point is that, over the long term, house prices appreciate with incomes; since the early 1960s, his data show that house prices have grown by 2.4 per cent a year after inflation - what economists call the real return.

Along the way, though, there have been lots of periods of dramatic fluctuation in house prices and many instances where individual cities experienced movements up and down that were very different from the national average.

The 1980s saw a big runup in housing prices, as demand grew from baby boomers establishing families and interest rates declined from their peaks in the early part of that decade. As house prices rose, affordability went down - by 1989, Canadians were devoting an all-time record proportion of their incomes to carry their houses.

This led to a substantial correction in housing prices and to a lost decade for house prices in the 1990s. In fact, Mr. Soper pointed out that house prices went down in the 1990s after inflation was taken into account, the only decade on record where this happened.

The past 10 years

By 2000, incomes had moved ahead of house prices, laying the ground for substantial appreciation over the past 10 years.

A recent report by TD Economics pointed to annual increases in house prices over the past decade of 8 per cent, among the highest in memory.

As a result, the percentage of Canadians' incomes devoted to carrying their houses has risen sharply to what Mr. Soper called the "affordable/expensive" level. The proportion of income dedicated to housing is not at the record levels of 1989 - but when mortgage rates rise, there is no question that some Canadians will be hard-pressed to carry their houses.

An academic's perspective

Another point of view comes from Cynthia Holmes, professor of real estate at the Schulich School of Business at York University.

Her research shows that over the very long term, average house prices go up with inflation - but typically don't provide much in the way of a real return at all.

She points to exceptions - for example, areas going through a transition in housing quality can experience she calls "windfall gains." She identifies substantial benefits to owning a house - it creates forced savings and can lead to psychological satisfaction from the pride of owning versus renting, but as a whole, houses have not been particularly good investments over the long term.

As evidence, she pointed to research tracking house prices in a central area of Amsterdam over 347 years, from 1628 to 1974. Price appreciation in real terms was very close to zero and nearly all of the growth in real value that did occur happened in two exceptional periods.

More on mortgages

  • Protecting a mortgage: Marissa and Marcello's story
  • Three ways to create income from a reverse mortgage
  • Should I buy a home now, or wait and save more money?
  • What does it really cost to borrow?
  • Ready to sign on the dotted line?
  • Getting the best mortgage rate

Price outlook

Psychologists point to a phenomenon called the recency effect - where recent events shape our expectations. As a result, some Canadians are expecting the kinds of appreciation on their houses they saw in the past 10 years - and are almost certain to be disappointed.

In a recent conversation with a group of retirees, a number talked about the "old days" of the fifties and sixties, when people thought about trading up in houses over time, without being concerned that prices would get away from them. One talked about considering the purchase of a more expensive house and deciding to wait - and five years later buying that same house at almost the identical price it would have sold for originally.

For the next while at least, people would be well advised to go back to the traditional reasons for owning a house, which is living in an environment they enjoy - and tempering hopes that their house will be a great investment.

Dan Richards is president of Clientinsights. He is a faculty member in the MBA program at the Rotman School at the University of Toronto. He can be reached at dan@clientinsights.ca


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