Toronto Condo and Real Estate Blog

From Scotiabank

By current metrics, the finances of Canadian households are in good shape. From an asset perspective, household wealth has reached unprecedented highs, thanks to years of solid, uninterrupted economic growth accompanied by falling unemployment and rising home and stock prices. From a liability perspective, indicators of balance sheet leverage appear in line with past norms, even as historically low borrowing costs have fuelled a steady rise in debt loads. And from a portfolio perspective, household assets remain well diversified despite a shift in favour of real estate assets this decade.

However, this performance will be tested in the months ahead as the global economy moves to a slower growth trajectory, real estate markets — at least east of the Prairies — cool off, and job growth moderates. In recent years, households have relied almost exclusively on outsized capital gains to build their wealth, a strategy that could have major implications for the aggregate consumer spending outlook. Simply a return to a historical pace of asset price appreciation would remove much of the strong ‘wealth effect’ that has supported bigticket consumer spending so far this decade. It would also force many households to raise their conventional level of saving to meet their long-term retirement goals.

At the same time, the typical household investment portfolio has become both less liquid and more exposed to market risk than in the past, reflecting the more rapid growth in holdings of stocks, mutual funds and tax-sheltered pension vehicles relative to  traditional cash and term deposits. This more aggressive investment strategy has been positive from a longer-term wealth-building standpoint. From a short-term cyclical perspective, however, it leaves households more exposed to adverse economic developments, such as a sharp correction in the buoyant housing market, increasing joblessness attributable to slower U.S. demand for Canadian exports, or increased financial market and interest rate volatility.

Among the major trends shaping Canadian balance sheets, five in particular stand out:

The collective net worth of Canadian households — the value of all assets minus liabilities — increased 10% in the most recent twelve month period, to a record $4.97 trillion. This brings the cumulative rise in household wealth in the past three years to an impressive 31%, or about 20% after adjusting for inflation and population growth. Given Canada’s roughly 12 million households, this translates into an average net worth of almost $400,000 per family (including roughly $100,000 in accumulated employer pension plan benefits).

Statistically, average net worth estimates are heavily skewed by households at the top of the wealth distribution. Statistics Canada’s 1999 Survey of Financial Security found that average net worth was roughly 2.3 times greater than median net worth — the latter being more representative of a ‘typical’ household. Assuming this ratio is still a reasonable approximation today, the median net worth of Canadian households is probably closer to $175,000 (including about $50,000 in trusteed pension fund assets).

Notably, wealth gains over the past several years have been broadly based by asset class, reflecting both the sustained nationwide housing boom that has pushed up real estate prices to record levels, as well as to the strong recovery in stock markets in the aftermath of the 2001 tech meltdown. The total market value of household real estate and financial assets has risen 26% and 34%, respectively, since the beginning of 2003.

Canadians have also been borrowing more, encouraged by their appreciating investments, historically low interest rates, and a consistently solid pace of job creation. Yet thanks to their asset gains, the ability to service this debt has not materially deteriorated. In fact, the ratio of total household liabilities (consumer credit and mortgages) to assets — a broad measure of household leverage — was slightly below its historical average in early 2006. In contrast, U.S. households, which have relied more heavily on home equity loans and mortgage refinancing in recent years, are facing record high debt leverage ratios.

Investors are altering their wealth accumulation behaviour

Canadians on average are saving less out of current income, instead relying on capital gains (both realized and unrealized) accruing from their real estate and equity holdings to build their wealth. The nation’s official savings rate — the difference between current personal income and expenditures — has fallen steadily over the past decade and a half, from over 13% in 1990 to a record low 1% as of mid-2006. Conventional savings rate estimates exclude contributions to social insurance and employer pension plans, non-discretionary savings that are deducted directly from paycheques. Adding back these deductions would lift the measured savings rate above 8%, but the declining trend would still persist.

From an economy-wide perspective, the household sector in Canada is an increasingly large net borrower of funds, reversing its long-standing position as a net lender. We expect this trend to continue as retiring baby boomers gradually draw down their accumulated savings, including those from employer and private pension plans. In the meantime, Canadian corporations and governments have stepped up as net suppliers of investment funds, more than compensating for the decline in personal sector saving.

On its own, Canadians’ decreased propensity to save out of current income is not a major cause for concern. Personal savings rates in most industrialized nations have been on a downward trend since the early 1990s, as rising wealth improved the overall financial position of many households. Solid economic growth and low and well-anchored inflation expectations may also have decreased the perceived need for a sizeable ‘rainy day’ fund.

As an asset-building strategy, however, the implications are dramatic. From 2000-2005, conventional saving by Canadians accounted for just 10% of personal sector wealth accumulation, compared with almost 30% in the 1990s. Last year, saving accounted for a mere 3% ($9 billion, or roughly $750 per household) of the aggregate $351 billion increase in national household wealth — the lowest on records back to 1990. The remaining 97% stemmed from asset price appreciation.

Looking ahead, many households may need to revisit their investment strategies as the heady pace of real estate and equity price appreciation inevitably slows. Generating even modest wealth gains may require boosting traditional savings and/or reining in discretionary outlays. At a macroeconomic level, the important ‘wealth effect’ underpinning consumer spending growth will likely diminish, reinforcing any economic slowdown already under way. Gains in real estate wealth are thought to be particularly powerful, as they are perceived as more permanent, and real estate is widely held.

Investment portfolios remain well diversified

Appreciating real estate prices, rising homeownership rates and a boom in renovation activity in recent years has shifted the composition of household wealth in favour of real assets — 80% of which represent real estate holdings. This is the reverse of the trend of the 1990s, when buoyant stock markets and an underperforming real estate market consistently favoured financial asset investments. From either a historical or international perspective, however, the exposure of Canadian households to real estate markets is not unusually high. Real estate assets accounted for 33% of all household assets in the first quarter of 2006, up 4 percentage points from the start of the decade but in line with its long-term average.

Again, average portfolio shares derived from aggregate balance sheet figures are not necessarily representative of a typical household. As real estate is much more widely held than equities, we expect it accounts for more than one third of most households’ total assets. The aggregate measures are nonetheless indicative of the exposure of the entire household sector to real estate and equity markets.

The reallocation between asset classes appears to have been driven more by cyclical considerations — pent-up housing demand, historically low borrowing costs and the steep equity market correction at the turn of the new millennium — than an underlying shift in investor mentality. Indeed, real estate’s share of total household assets peaked almost two years ago amid the general recovery in stock markets globally. Longer-term, growing investor risk tolerance and sophistication, and the historically higher average returns to stocks over housing, should favour financial assets over real assets.

Demographic trends (i.e. an aging population) also favour financial assets. Younger households that are just beginning to establish themselves financially tend to focus on accumulating real assets such as durable goods and first homes, while older households focus on retiring mortgage debt and building their financial assets for retirement. Because households often trade up to larger, more expensive homes during their lifetime, however, the real estate share of most portfolios historically hasn’t begun to decline until around age 45 — perhaps even later today given increased longevity and life expectancy.

Maintaining a diversified portfolio of assets is important to managing the inherent risk in any investment. Notwithstanding the recent strong gains in both housing and stock prices, the correlation between real estate and equity market performances historically is quite weak. For most of the 1990s, for example, rising stock prices compensated for largely stagnant home valuations. Adding real estate assets to financial holdings could lower the overall volatility of household net worth.

As an investment, however, housing is not without risk. It provides diversification compared with a portfolio consisting entirely of financial assets, and has a relatively lower risk of nominal price decline than for many other investments. But given the magnitude of the principal residence to total assets, and the high degree of leverage used to finance it, too heavy a focus on housing could leave a household highly exposed to regional house price developments.

Financial assets are becoming less liquid

The relative percentages allocated to various financial assets have also shifted, generally toward less liquid investments. Stocks and mutual funds, much of which are held in tax-sheltered retirement plans, accounted for 37% of all household financial assets in early 2006, double the share in 1990. Over the same period, the accumulated value of household life insurance and employer pension plan funds as a share of total financial assets increased 5 percentage points, also to 37%.

Meanwhile, Canadians have been steadily reducing their holdings of lower yielding, lower risk cash and other short-term deposits, which now represent just 11% of household financial holdings, down from 19% in 1990. This reduction in liquidity is the natural outcome of an aging population and a low inflation environment. In the event of an unexpected economic downturn, however, it could leave many households with a limited savings cushion to draw on.

Households are taking on greater market risk

The rising share of household assets invested in real estate, stocks, mutual funds and pension funds, and the corresponding decline in holdings of cash, savings bonds and term deposits, has increased the exposure of Canadian investors to market risk. We estimate that roughly 21% of household assets at the end of 2005 were invested in high market risk holdings (i.e. stocks and mutual funds), more than double the comparable share in 1990. Meanwhile, investments in low risk savings vehicles (i.e. cash and term deposits, mortgages and savings bonds, and consumer durables) dropped from 35% to 21% of all financial assets. The remaining 56% could be categorized as medium risk (i.e. real estate, pension funds, and foreign and other investments).

Rising market risk does not imply that the overall financial health of Canadian households is unduly exposed. Indeed, households’ rising net worth relative to income suggests a greater ability to weather increased market risk — and generate larger long-term investment returns. However, along with reduced liquidity and a shift to price-appreciation based wealth accumulation, short-run changes in wealth and consumer spending may ultimately prove more volatile than in the past.

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Contact the Jeffrey Team for more information

Home inspections used to be initiated almost exclusively by the buyer in a real estate transaction. However, pre-listing inspections, paid for by the seller before a house is put on the market, are becoming an increasingly popular way for real estate agents to try to reduce the possibility of last-minute surprises and create a marketing edge.

A prelisting inspection may lead to a house selling without conditions. It can be a great learning tool for a real estate agent to help him speak more knowledgably about the house he is trying to sell, and it can help the seller prepare the Seller Property Disclosure Statement (SPIS).

“The pre-listing inspection (PLI) is advantageous to sellers, buyers and real estate agents as it can help establish a fair price for that home in that location in today’s marketplace,” says Andrew Dixon, President, Ontario Association of Home Inspectors (OAHI).

“A PLI can help the seller and their real estate agent by identifying areas where improvements and maintenance may be beneficial and/or necessary. A buyer can purchase with the confidence of knowing that the home has been inspected by an unbiased professional whose primary responsibility is the state of the home and its systems.”

According to the OAHI, any home inspection including a PLI is concerned with the defects and the lifespan of the systems of the home. The PLI report should include all the major defects and the minor defects that could develop into major defects (either structurally, monetarily or safety related) over time. The inspector should provide justification for most items identified such as pointing out what needs attention to avoid premature deterioration.

While thorough, the PLI doesn’t comment on the aesthetics or curb appeal of a home. “The pre-listing home inspection is a visual examination of how the house is performing in the field,” says Alan Carson, Vice-President, Carson Dunlop.

“We’re looking to see if this house is going to do its job in terms of comfort, safety and durability. The fact that the carpet is stained is not going to show up in a PLI and it’s not a code compliance review either.”

Carson says pre-listing home inspection are concerned with the nuts and bolts of a house. For example, does the roof keep water out, do doors and windows operate properly, does the furnace keep the house warm and the air conditioning keep it cool and do the plumbing and electrical systems do what they are supposed to do?

“Home inspection is a building science not a health science,” says Carson. “Health scientists are concerned with what we are breathing or ingesting, but home inspectors are not generally trained in health science. To us mould is a sign that there’s moisture where it shouldn’t be.”

However, both Dixon and Carson say that if mould or other potential health hazards are uncovered in the PLI, the home inspector will recommend further investigation. However, while reducing the “need” for a buyer’s home inspection, the PLI does not eliminate that possibility, says Dixon.

Listing real estate agents can add value to their services by suggesting a PLI and helping clients to find a qualified home inspection company to conduct the pre-listing home inspection. “To judge the thoroughness of an inspection company always ask for referrals,” says Dixon.

“Check their web site, ask for their standards of practice and risk management policy, what their follow-up procedures are and examine the contract.” He says the contract should be consumer friendly, easy to understand and should clearly identify what-is and what-is-not inspected.

In addition he suggests asking for association membership, level of membership and level of education, whether the inspector is a sole proprietor or member of an inspection firm. “Above all, identify your expectations and ask the inspector if they can be met. Ask for a thorough but impartial inspection of the home, clearly identifying the concerns in an efficient and straightforward manner with recommendations as required.”

Even if sellers decide not to make any of the suggested fixes, a prelisting home inspection can still prove beneficial by allowing sellers to obtain cost estimates for needed work, so they can offer potential buyers an appropriate discount off the listing price.

“Many people wouldn’t agree with me, but I believe in most cases that the seller shouldn’t replace the roof or the furnace or other high ticket items,” says Carson. “If I’m the buyer, I want to choose the colour of the shingles or get the most efficient furnace and have warranties. I’d encourage the seller to say the price reflects the need for a new roof or furnace instead.”

Finally, both Dixon and Carson feel that it is always a good idea for the real estate agent to be on hand for the home inspection. “It is always advisable to have all concerns identified and questions answered in person. Things can get lost in translation and the waters muddied,” says Dixon.

Repairs are more than just a facelift

Here are the most common fix-ups for home sellers according to the OAHI. All are relatively low cost and many are safety items. Most are also expected in any home no matter what the age and would increase or at minimum guarantee fair market value if completed.

1. Fix any basement crack & get a warranty – especially when the inspector tells you it has leaked - no matter how much over how many years!
2. Extend the downspouts to discharge water well away from the home.
3. Prep and paint the exterior wooden trims/frames/doors, etc.
4. Put a handrail where needed.
5. Make sure the smoke alarms test and work properly and are on every floor.
6. Repair or replace the defective GFCI outlets.
7. Upgrade to a 100 Amp service with a combination panel and breakers.
8. Do a roof tune-up or get a new roof.

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Contact the Jeffrey Team for more information

When it comes to the single largest investment most of us will make – buying a home – consumers want to make sure they’ve protected that investment to the best of their abilities. As real estate agents, providing them with sound, knowledgeable advice will maintain their confidence, and perhaps their business.

When it comes to protecting that investment, one option to consider is title insurance – a cost-effective protection that shields homebuyers from many of the major risks that can affect the ownership and/or future marketability of title to a property. Like all insurance policies, title insurance is a contract of insurance that comes with terms and conditions. To get the most value out of the title insurance policy, it’s important that homebuyers understand how title insurance works, and what risks title insurance does and does not cover.

Why even consider title insurance? Because the unexpected can and does happen. The most typical situation in which homebuyers call on their title insurance policies involves unpaid utility or realty tax bills from the previous owner. The second most frequent category of claims relates to building code issues. For example, a couple buys a house planning to add a new wing to their home. When the building inspector arrives for an on-site inspection, he discovers that an earlier renovation was not done to code, and the whole home needs to be rewired. If the owners have a title insurance policy in place, the insurer could compensate the homeowners for the costs of bringing the electrical work up to code.

Title insurance also protects homeowners if the house is not located on the property accurately and encroaches onto neighbouring land, or if a pool has been built that is actually on a neighbour’s property. A title insurer could resolve this problem by buying the piece of land that the house (or pool) actually sits on from the neighbour, and taking care of all the related legal work.

Condominium owners have also found title insurance protection useful. Take the example of a newly built condominium unit purchase. The buyer of a particular unit is shocked to find out that the unit purchased is a different unit from the one that he or she was expecting to buy. Unfortunately, the unit actually acquired is worth less because it does not have a “lakefront” view. In this instance, the legal services coverage available through the TitlePLUS policy was called on, and the buyer was compensated for the difference in value between the unit he took possession of, and the unit he thought he had bought. This legal service coverage, which protects buyers for losses suffered as a result of the negligent errors of their lawyer, may not available from most other title insurance companies.

Title insurance can also benefit buyers in other ways: It can eliminate the need for an up-to-date survey while protecting against any title-related issues that would have been identified by that survey.

Fraud protection

For many buyers, the fraud coverage provided by title insurance is particularly reassuring. Title insurance can protect homeowners if they are the victim of fraud, and may also pay the costs involved in defending their ownership in the property and restoring their title to the home.

As with any type of insurance policy, certain exclusions will apply. Typical issues not covered include, native land claims, environmental hazards and the buyer’s rights to change the use of the land or undertake renovations or construction. Problems the buyer agreed to in the purchase agreement or failed to disclose to the lawyer will also not be covered. It is therefore vital that buyers tell their lawyer of any problems that their real estate agent advised them about or that came to light when visiting the property. As well, individual policies may contain exceptions specific to the homebuyers’ property. For example, minor utility easements or rights-of-way for a mutual driveway may be specifically listed as exceptions to coverage.

Bear in mind that, in general, if the problem is not a “legal problem”, it is likely not covered. Title insurance provides protection against title-related problems; it is not home warranty insurance, and will not protect homebuyers if the fridge breaks down or the furnace gets old. As with any insurance purchase, the homebuyer should consult the policy for full details of the actual terms and conditions and seek advice from a real estate lawyer. When purchasing a home, a real estate lawyer can help the buyer sort out the various protections offered by different title insurance companies in order to get an idea of which risks are covered and which are excluded.

To help homebuyers better understand the benefits of title insurance, and the role of a lawyer in a real estate transaction, TitlePLUS insurance has created a free Real Simple Real Estate Guide. You can access the guide by going to www.titleplus.ca.

This article appears courtesy of TitlePlus. Nadia Dalimonte is student-at-law at LAWPRO. Kathleen Waters is vice president,TitlePLUS.

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Contact the Jeffrey Team for more information