This is the latest in a series of video interviews in which Pat McKeough will give his advice on a variety of topics. Some will deal with his overall investment philosophy, others on specific investment strategies and still others will be comments on events that are affecting the markets and the economy. In this session, Pat responds to a question about those analysts who are making grim predictions of a looming stock market crash. He introduces a note of calm, pointing out that when it comes to real estate investments, just because a boom cools down doesn’t mean it’s going to go bust.

Should You Worry About a Real Estate Crash?

Q: Pat, some analysts are predicting a crash in the real estate market. Is this a realistic fear, or just another case of jumpy analysts making doomsday predictions?

Pat McKeough: Anytime anybody talks about a “crash”, it covers a wide range of activity. In the early 90s, an analyst got on the front page of the Globe & Mail because he was predicting a 25% crash in Toronto real-estate prices. And real estate brokers jumped all over him, telling him to stay out of their business, you don’t know what you’re talking about, and so on. But it in the end, it turned out he was right, at least in terms of the Toronto housing market.

That was partly because prices got high in relation to people’s incomes, so new buyers weren’t able to buy the house they wanted. Also, because of a rise in interest rates, the average homeowner’s mortgage payment went up. As a result, the price of an average house came down. This was a price adjustment, not a collapse. It wasn’t as if people were getting thrown out of their houses because prices had gone so low. It was just basically an adjustment in prices. But that only matters if you want to buy, sell or refinance.

So you can call that a crash. It’s a crash if you’re buying on margin or if you’re highly leveraged. But it’s not a huge crash the way that the crash happened in the States in the previous six or seven years, when prices really fell through the floor. Prices fell 50-60% in many areas in the States.

I don’t see any kind of crash like that here in Canada, and I think the damage is already done in the States in terms of the real estate market. But I do think that you won’t get as much growth in homes in say, the Toronto area or the Vancouver area for a number of years, because house prices have gone up high in relation to people’s incomes and interest rates are low in relation to the historical record. So there’s a possibility that people will run out of borrowing power, especially if interest rates move up again to more normal levels.

So I would say that it’s always a good idea to buy your own personal residence, because of the tax advantages. But to buy a second residence, I wouldn’t say that’s a great idea right now unless you want to be a landlord, unless you make that a part-time job. And even then I wouldn’t be too keen on the idea.

So the answer is: real estate is not a great area of opportunity right now, but it’s not terribly risky as long as you keep it a reasonable part of your total net worth.

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