Don't count on your home to fund your retirement

Source: Globe and Mail


One thing I often say to clients and readers of my website is that the next decade for real estate prices in Canada will look nothing like the past. There are three main reasons for this:


1) The capacity for house prices to outpace income growth by two to three times in most Canadian cities, as they have over the past decade, simply will not be possible as interest rates will eventually begin to rise.


2) The past decade saw a loosening in credit requirements, but in 2009 things began to change. The availability and cost of mortgage credit has been a fundamental driver of the current housing boom, and recent trends toward stricter mortgage underwriting strongly suggest that credit conditions will tighten in the coming years.


3) Demographics. This one’s potentially a big one, and is what I want to discuss today.

In August, 2010, The Bank for International Settlements (BIS) wrote a great report on the impact of an aging population on asset prices. It noted the following:

The paper identifies the impact of aging through the analysis of house prices. It finds that demographic factors contributed positively to real house prices in many countries in recent decades. For instance, the United States is estimated to have enjoyed around 80 basis points per annum demographic tailwinds in the past forty years compared to neutral demographics.


The author calculated that demographic factors have led to a real house price increase of roughly 20 per cent over the past 40 years in Canada. That is, there has been a 0.5 per cent per annum tailwind driving real (inflation-adjusted) house prices. This paper notes the following:

Looking ahead, forecasts … uniformly point towards substantial demographic headwinds.

…The young save for old age by buying assets, while the old sell assets to finance retirement. This asset transfer can happen directly or through institutions such as pension funds. In this setting, the change in the relative size of asset buyers (the young) and sellers (the old), have consequences for asset prices. In particular, the asset purchases of a large working age generation, such as the baby boomers...drives asset prices up. Conversely, if the economy is aging, i.e. the subsequent younger generation is relatively smaller, then asset prices decline.


Now for the bad news: The author calculates that demographics alone will have a 1 per cent annual drag on house prices in Canada into the foreseeable future.


To understand this imbalance, it’s important to understand when age groups become net buyers and net sellers of real estate. This topic was explored in an interesting paper in the Journal of the American Planning Association. It concluded that groups of people become net sellers of real estate after the age of 65, while net buying of real estate is most pronounced between the ages of 25 and 35. If those findings apply to Canadians, we can easily see the problem by simply looking at the age distribution of the Canadian population:


Granted this does not consider the offsetting influence of net immigration, but it’s easy to see how that paper came to the following conclusion:

What have not been recognized to date are the grave impacts of the growing age imbalance in the housing market. If the elderly are more often home sellers, and are more numerous than the young who are buyers, a market shift could come on quickly after 2010, causing housing prices to fall. Even if prices remain flat, without the investment incentive young households will likely slow their entry into homeownership, worsening the imbalance between sellers and buyers.


This poses a particular problem for the Canadian housing market when we consider how many near-retirees are planning on using home equity to at least partially fund their retirement. A 2011 RBC survey estimated that number at 56 per cent. What this does not tell us is what percentage plan on accessing that equity through a reverse mortgage or HELOC and how many plan on accessing it by selling and downsizing or possibly renting. That remains up for speculation. Nevertheless, we can certainly assume that downsizing is in the plans of a significant portion of these households.


This leads me to a few conclusions:


1) It certainly seems reasonable to assume that downsizing will put pressure on the higher end of the market as empty nesters sell their larger homes to downsize into smaller, more age-friendly homes. Current demographic trends suggest that the demand for these large homes is unlikely to persist at current levels. In 1975, the average single family home in Canada was 1050 square feet. In 2010, the average new home being built was nearly 2000 square feet. Yet over that same time, the average household size has fallen by a third. This is a trend that simply will not persist indefinitely and I suspect these larger homes will fall out of favour over the coming years, unfortunately just as many try to capture their equity gains and downsize.


2) The flip side of the first conclusion is that smaller, age-friendly homes (including condos in areas where new construction is not rampant) will see a relative floor put under them. The end result is price compression in the market whereby the larger, more expensive homes fall in price to a greater degree (or as a best case scenario, appreciate more slowly) than smaller, age friendly homes .

The implications are clear: If you are counting on current home equity to at least partially fund your retirement and are hanging on for that last bit of capital gain before selling, you are playing a dangerous game.

Analyst and strategist Mr. Rabidoux covers Canadian macro economic trends with a focus on housing and consumer credit. He also has a website,

Source: Globe and Mail

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