Negative effect of falling real estate prices poses challenges for pre-retirees and retirees alike
A year after the pandemic-driven real estate boom stoked bidding wars and reignited debates over housing affordability, inflation and rising interest rates are bringing home prices back to earth – which could have implications for retirees and near-retirees across the country.
In an October report, Royal Bank of Canada noted that home values rose by 52% during the pandemic, helping Canadians amass $3.9 trillion in net wealth. But roughly $900 billion of that has evaporated as rising interest rates and flagging financial markets cause a retrenchment in housing markets.
The Big Six bank forecasts a total of $1.6 trillion in losses to net wealth in quarters ahead, equivalent to a 41% retracement in the net worth gains fuelled by the pandemic. The upshot, it said, would be a negative wealth effect that could leave Canadians less confident about spending.
“Everyone is certainly feeling the pressure of lower net worth and rising costs,” says Brenda Hiscock, CFP and financial planner at Objective Financial Planners. “Inflation is having an impact on the costs of goods and services, but also interest rates on debt are rising at an alarming rate.”
According to Hiscock, many of her clients, particularly those entering or already in retirement, are deeply concerned about the effects of long-term inflation or recession on their finances.
In a recent Ipsos survey conducted on behalf of Manulife, nearly nine in 10 Canadians (87%) said that the country is either on the brink of recession or already in one. Within that group, more than half (56%) expect the recession to persist for at least a year.
Meanwhile, among Canadian retirees surveyed in the 2022 Fidelity Retirement Report, more than a third (35%) said they do not have the retirement lifestyle they were hoping for; when asked why, the top two reasons those respondents cited were not having enough money saved for retirement, and inflation. Those were also the top factors cited by pre-retirees who were asked what’s holding them back from retiring when they’d like to.
“People who require their home to fund their retirement have three options: they can sell it and rent, they can downsize, or they can enter into a reverse mortgage,” Hiscock says, noting that each situation should be explored individually based on clients’ preferences, cash needs, and other considerations. “My clients who plan to use their home to fund their retirement feel very concerned with rising costs of borrowing.”
With real estate values potentially not growing as fast as they’ve done in the past, Hiscock says retirees are not likely to have as much borrowing power as before.
“More than 11% of the Canadian economy (as measured by GDP) is based upon real estate-related consumption expenditures and residential investment,” she adds. “So that’s likely to slow.”
For its part, RBC expects households, faced with rising interest rates and rampant price pressures, will soon have to allocate 15% of their income towards debt servicing, with half of that going to mortgage costs.
“Borrowers will have to make higher payments on variable-rate secured and unsecured debt, and borrowers with fixed-rate mortgages coming up for renewal will face higher monthly payments,” Hiscock says. “For those wanting to borrow against their home, their borrowing power reduces if the home value dips.”
Overall, the challenging economic climate raises important questions about the well-worn playbook of using real estate for one’s retirement. As real estate prices go parabolic and come back to reality, Hiscock says people who bought a house that they’ll never pay off before retirement should be realistic about the likely headwinds.
“The days of double-digit growth may be gone, and currently so are low rates and mortgage payments,” she says.
While the negative effect of sinking real estate prices is putting pressure on all homeowners, some are finding creative solutions. According to Hiscock, some of her clients are converting their larger homes into two units, or even building a second unit on their property, which helps generate additional rental income.
“Canadian retirees and near-retirees should work with a planner to see what’s possible under various scenarios, and review their spending for areas where they may cut back,” she says.
Brenda Hiscock is a fee-only, advice-only certified financial planner (CFP) at Objective Financial Partners Inc. in Toronto. She does not sell any financial products whatsoever. She can be reached at here.
