Investing in housing: An art or science?



Kunal Sawhney, chief executive of Kalkine Group 

Is investment an art or a science? Or is it both an art and science? Many would say it is pure science, and investors must know how to apply facts and numbers before taking an investment decision. For others, too much of computing can hinder possibilities of wealth creation, and hence, it’s an art.

While this debate may go on forever, investors in the hot housing market of Canada will be better placed when some application of facts and numbers backs investment decisions. There is little doubt that the frenzy is likely to sustain in the near-to-medium term despite sale figures declining in the last few months.

Prices are still high. Most analysts feel the record low benchmark rates of the Bank of Canada are to blame for rising demand. Moreover, Canadian households are sitting on a record high cash pile, thanks to government stimulus and pandemic savings on fuel and other costs.

But such factors can only shape a buying decision, not the returns the asset yields for the investor. For example, smartphone apps may have brought stock trading to the doors of young Canadians, but returns for any investor will be determined by how the purchased stock behaves.

Housing markets are slowly losing momentum

The growth in house prices in Canada is comparable with housing markets of the US and the UK. Even in New Zealand and Australia, the demand is very high. However, in the UK, a correction has hit the market lately.

In the UK, the yearly increase in house prices was at a 17-year high in June this year. A key driving force was the stamp duty waiver announced by the government after the pandemic struck. The tax holiday is now being withdrawn.

According to reports, prices in July have dropped compared with the preceding month. The future of the housing market in the UK is anything but certain, and forecasters are adopting a wait-and-watch approach. Housing activity can swing in any direction even as the economic downturn persists and the clock ticks on the withdrawal of pandemic support schemes.

In Canada, an unwinding of sorts has hit the market. In June, both the number of houses that changed hands and the price were down compared with May. After hitting a peak in March, housing activity has dropped in every subsequent month in terms of sales. Prices are still high on an annual basis. The Bank of Canada governor, Tiff Macklem, had also lately termed real estate as a vulnerability in the Canadian economy and that a trigger event for a wide correction can hit at any time.

If the withdrawal of tax breaks in the UK acted as a trigger for the price drop, it could be the Bank’s reversal on low benchmark rates and quantitative easing for the Canadian housing market.

Will all real estate investments create wealth?

Any price crash or correction aside, a key concern is whether investments will bring intended returns?

In the US, institutional investors, including BlackRock and Goldman Sachs, are being blamed by some for skyrocketing affordable housing prices. While it is true they are buying rental homes; it is also true that these seasoned players factor in all prospects while making an investment decision. In April, a prominent investor reportedly bought an entire neighborhood comprising of single-family houses in Texas.

According to an analysis, big investors like Invitation Homes recover the money parked in a housing asset within eight years of purchase. This is because rental payments from assets bring back the entire purchase amount for the investor within this short period and all returns beyond that are pure profits.

While all institutional investors are aware of the ‘1 percent rule’ in real estate (investors should calculate monthly rent to be at least 1% of the total purchase price), amateur non-institutional investors rarely care for such science in investment. The rule says monthly rental income from any property bought for investment purposes must be at least one per cent of the total purchase price. By this calculation, the purchase amount can be recovered within eight years.

Inflation in most economies, including the US and Canada, has lately hit record levels. As a result, rental payouts are also rising. It can mean that although house prices may eventually fall, rental income may yield enough returns for the investor.

Wealth creation may not be identical for all

This is a broad perspective, and a lot is likely to depend on a case-to-case basis. At this point, there is a broad consensus that housing markets of suburban communities in Canada will continue to outshine downtown areas. As per reports, house price growth in some rural areas dwarfs growth in Toronto and other major cities. Urbanites are flocking to suburban areas in record numbers.

The ones acquiring a house for personal use, not as an investment, have little to lose in the craze for suburban parts subsiding. However, for investors, the asset will yield returns only when the craze sustains even after the economy and social landscape return to normal pre-pandemic days.

Real estate investment can be a little tricky when the market is too hot. Many new investors attempt to jump onto the bandwagon with limited knowledge of some golden real estate investment rules like the ‘1 percent rule. Stimulus cash, pandemic savings or sub-one per cent mortgage rates can be the driving force behind any purchase. Still, the asset will only create wealth for the investor when science and calculation is applied prudently.

A few other rules of thumb in real estate investment like the 70 percent rule that applies to flipping houses or the modified form of 1 percent rule- the 2 percent rule that says positive cash flow from an investment property is assured when monthly rent is at least 2 per cent of total purchase price- can be also considered.

When investing in a hot market, investment is more a science than an art.

 

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