All About the Canadian Housing Market

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Bipan Rai: So I’m going to ask you the question that we all get asked at a dinner party when it comes to the housing market, will we ever see that corrective move that so many have been predicting for so long now? And why or why not? And what causes that move when it does eventually come?

Benjamin Tal: Yeah, this is not a market that is in a bubbly situation.

Bipan Rai: Hello, everyone, and welcome to another edition of the X Factor podcast brought to you by CIBC Fixed Strategy for this episode, we’re going to touch on a pretty interesting topic and certainly one that everyone has a view on, but so very few people actually know what they’re talking about when it comes to this market. It just so happens that I have one of the most foremost experts on the sell side when it comes to the Canadian housing market and also one of the pre-eminent economists in Canada, Benjamin Tal. Benny, thank you for joining us on this episode. And of course, we’re going to do a deep dive into the Canadian housing market since you did touch on that in our year ahead piece that was published on December the 1st. How are you doing today, Benny?

Benjamin Tal: Excellent. Excellent. Thank you.

Bipan Rai: Excellent. It’s good to have you back. So the first question I want to ask you, Ben, is in your year ahead a contribution. You touched upon this anecdote that you went to an IMF investor’s day over 10 years ago, and even back then, investors were sort of looking at Canada in the housing market and considered it bubbly then and up until the beginning of the pandemic, or just shortly before the beginning of the pandemic, we had seen house prices in Canada doubled. In your view, what were the reasons for that increase?

Benjamin Tal: Yes. As you know, for more than a decade, people were talking about this bubble housing market. I remember, you know, somebody from a hedge fund manager from New York coming to my office directly from the airport arrived to my office, didn’t even take his jacket off and said, You guys are going to crash. And I said, why? And he said, Because I can’t accept 35 cranes from the airport to your office, you are going to crash. And I asked back then, do you have any more sophisticated way of looking at your analysis? So what I’m saying here is that this notion of Canada being pricey and bubble has been there forever. And it’s not crushing. Why? Because the number one issue and people are not getting it. The number one issue is supply. We are getting 400000 new immigrants even this year. We are getting four hundred thousand new immigrants. We have this huge demand coming. There is so much money in cities like Toronto, Vancouver. Interest rates are relatively low and you don’t have enough supply. Vancouver is an island. Toronto, from a relative perspective, is an island. Because of policy, it takes forever to release land to release permission to build. This is not a normally functioning market, and we have been using demand tools to fight supply issues. That’s the number one reason why prices have been rising and will remain elevated. And of course, you have very strong demand in an environment of falling interest rates. That’s the story.

Bipan Rai: So it certainly does jive with some of the anecdotes that I’ve heard from some of the other experts in the area as well. But since the pandemic began, we’ve seen something else interesting as well. I mean, in the course of a recession, we’ve seen house prices continue to appreciate. I mean, this is usually a typical for what we see during a recession. What are the reasons you think for this increase?

Benjamin Tal: Yes, that’s a very good question, because until the pandemic, I have all kinds of models and I was able to basically explain ninety five percent of the increase in prices since the pandemic. None of my models can capture this increase, and if I cannot explain something, it cannot be good. So what I suggest there is that something happened here that we have to understand, and this something is the asymmetrical nature of this crisis, as we discussed in earlier conversations. Basically, all the jobs that were lost during this pandemic were low paying jobs, young people, rentals, you know, homebuyers, potential homebuyers. They did not feel the crisis financially. In fact, they are doing better. So if you think about it for a second, for the first time during a recession, home buyers are able to take advantage of what the recession can give you vis a vis extremely low interest rates without the cost of a recession vis a vis a broadly based increase in the unemployment rate. We have never seen anything like that in history. This asymmetrical nature of the crisis, the recession and the recovery is the secret behind the success of the housing market. There was this sense of urgency to get into the market, and people basically accelerated their purchasing activity, which means that in many ways we have been borrowing activity from the future. That’s why we are going to slow down. But for now, there is logic behind the madness. If you understand the nature of this

Bipan Rai: Crisis, right, those are very salient points. And you also look at these sales to listing ratio in your note, and you mentioned that it’s been well above what would be considered a normal balanced market usually. I mean, what does this mean for the market? Does it mean that we’re too frothy right now when it comes to Canadian housing?

Benjamin Tal: Well, first of all, it means that the market is very, very tight. Why you look at sales Before the crisis, there were about forty thousand units per month in Canada. Then it went to seventy thousand, which is crazy, and then went down and stabilising at about fifty thousand ten thousand units more than before the crisis. That’s demand supply is back to where it was before. The crisis, so demand is stronger than supply. That’s why prices have been rising, that’s more or less where we are. This is not a normally functioning market. This is a very, very tight market. Inventories are back to historically low levels, so that’s something that we have to consider. Now the question I’m asking myself is how people can afford this increase in prices. And we looked at something that I think is very interesting and I would like to share with you. And that’s basically gifting parents giving money to kids now, until now is a gift thing gifting interesting but not very interesting. But you know what? It’s very interesting because the numbers are huge. One third of first-time homebuyers are now getting a gift from their parents.

Benjamin Tal: One third, the average gift is about eighty thousand, and then another 10 percent of mover uppers are getting a gift, and this gift is much more significant. For example, that gift in Vancouver is about three hundred and forty thousand dollars. That’s a gift. And if you really want to understand the trajectory in the housing market, you cannot ignore this factor. And this is just the beginning, because I believe that we are in the midst of the largest transfer of wealth in Canadian history, and the way it works very quickly is that you have older people in their 80s and 90s. You have their kids in the fifties and sixties and then you have their kids. And I think that the inheritance is skipping a generation and going to the young families that are now buying a house. In addition, we are sitting on about ninety five billion dollars of excess cash. So the parents are writing a check. There is this sense of urgency to get into the market, and that’s exactly what we are seeing. So this is another factor.

Bipan Rai: So having said that, are we going through a structural shift in the housing market with sales and listings being well above prior periods? And also the fact that we have all of this wealth being transferred, even skipping a generation as well? Is it accurate to say that we should look at the housing market through a different lens than we have in the past?

Benjamin Tal: The short answer is yes. I do believe that this housing market will remain tight. It will remain expensive, and places like Toronto and Vancouver will remain unaffordable and will become even less affordable. However, it doesn’t mean that prices will continue to rise forever at this rate. You cannot sustain 20 percent a year. But what I’m suggesting is that, for example, I suggested that now sells at about 50 thousand units per month. It’s accelerating now. Why is it accelerating? Because interest rates are starting to rise, and we see this a non-linear nature of housing activity vis a vis interest rates. Whenever interest rates start to rise, people get into the market before this opportunity ends, so we will see some acceleration in activity in the next few months. Again, borrowing activity from the future, which means that you will see actually prices rising faster over the next few months. And then we will basically stabilise and rest a little bit with the impact of higher interest rates impacting the market. So that’s something that I’m seeing in the second half of the year. So it’s going to be non-linear overall. Can we see prices going down in twenty twenty three, twenty twenty four when interest rates continue to rise and will discuss rates later? Yes, we can. But this is not going to be a major crash. The only thing that can derail this market in a very significant way is the monetary policy error in which central banks will start raising interest rates like there is no tomorrow and basically derail the market. Every economic recession, every housing market crash was triggered, if not caused by monetary policy or so. That’s the number one risk facing the housing market. But without this kind of risk, without this happening, I don’t see what will trigger a significant correction in that market.

Bipan Rai: So going back to again to activity, I mean, you know, in the housing market primarily, is this a story for large urban areas or are we seeing this outside of the big metropolitan areas like Toronto and Vancouver as well?

Benjamin Tal: Well, we know that during COVID, we have seen something very interesting and that people live in the cities and going to some markets, but I think it was exaggerated just to give you some numbers. It is true that some people left Toronto and went to places like Bury and other places two hours drive. But if you look at the overall transactions, it’s about five percent of overall transaction, which means that Toronto, Vancouver, Montreal are still the centre of the universe. And now it’s reversing itself. It’s reversing itself because people are starting to realise that the city is back. You see, when the city is shut down, the premium of living in the city is zero. You open up all of the sudden, the city, there is something to do there. So the premium of living in Toronto, Vancouver, Montreal is basically higher and people go back. And when they go back, they go back to what the condo space. And that’s why the condo market is actually doing better than the low rise. So let’s talk about this segmentation of the market because I think it’s very important early in the pandemic.

Benjamin Tal: In fact, the first year we. In a situation in which high is low means they touch houses that are more expensive, they are not went up dramatically because everybody wanted to buy and live in a low rise as opposed to a condo for obvious reasons. Now, at any point in time, average price, the factor of two things one is simply the price rising the value. The other is the compositional factor. Namely, I’m much more activities happening in the more expensive segment of the market, namely low rise. And when you have more people buying detached houses, the average price goes up because there is more activity in that segment of the market. 40 percent of the increase in average price was because of this compositional factor today. That factor is actually negative y because people are moving away from detached houses because they’re unaffordable and they go to the more affordable segment of the market. Thus, the condo space in the city is back. That’s another factor. So the condo market is doing better, meaning that the compositional factor is actually negative when it comes to the contribution to average price.

Bipan Rai: And do you see that trend continuing into 2022? Do you see condo prices outperforming relative to detached and semi-detached houses?

Benjamin Tal: The short answer is yes. Absolutely yes. I see the market looking at what’s affordable. The market is coming back to the city. The city is not closed. It’s not dead. The opposite is the case. And when it comes to low rise detached houses, I believe that we are reaching very closely, very quickly. I call the resistance level. Prices are too high. People simply cannot afford it. So you go to what’s affordable, that’s the condo space. So I see the condo space doing better than the low rise in terms of price appreciation.

Bipan Rai: Now let’s chat a little bit about the elephant in the room, and that’s monetary policy here in Canada. I mean, it’s no secret that historic levels of interest rates have been an integral contributor to the rise in house prices in Canada, as you alluded to earlier. But you know, our call here at CIBC is that we expect the Bank of Canada to begin hiking rates next year. For those of you that are wondering, we have the Bank of Canada hiking rates three times in 2022 and an additional three times in 2023. Now my question to you, Betty, how does the Bank of Canada tightening rates affect the housing market in Canada next year? You touched on a little bit, but can you go a little bit deeper?

Benjamin Tal: Yes. First of all, I sure hope that the Bank of Canada will go no more than three times. The last thing you want to do is to shock the market and basically follow what the market is pricing in now, which is five six times. I don’t think that will happen. I think that the Bank of Canada knows better start early. You start in April and basically buy some insurance, see what’s happening with the variant and continues, you don’t want to shock the market. You know, I would make the point that even the mother of all recessions was triggered, not cause triggered by the fact that before that, Greenspan took interest rates from one twenty five to five percent basically over the course of breakfast. And that’s something that triggered the crisis. You want to move slowly, allow the market to adjust. Assuming that’s the case, then you have two things happening. One, the impact on people who already have a mortgage but have to renew that mortgage and then new buyers. Let’s focus on the people who renew it. Actually, the impact is not as significant as perceived. Why? Because we are lucky that the last time interest rates went up were when two, seventeen and 18, five years ago. Now our mortgage market is basically everything is based on five year, five years. So what happened five years ago, even for variable rates? Your fix for five years in terms of the combination. Therefore, if you look at interest rates back then compared to interest rates today, you can play with that and allow the Bank of Canada to go buy basically 100 basis points before actually feeling the pain. So there is a little bit of immunity to borrowers that are actually renewing their mortgage now, and that immunity will be for people who renew in twenty twenty two, twenty three and twenty four. However, if you got your mortgage during COVID in twenty and twenty one and you renew in twenty five and twenty six, you are exposed because those were extremely low interest rates. And if interest rates remain elevated after the Bank of Canada raises interest rates and go back to semi-normal, let’s say the bank rate at two percent just a reasonable guess at this point. That’s a significant increase for them. And this is the cohort, the call that took a mortgage in twenty twenty one that everybody has to watch and how much equity they are building during this process, how much they accelerate their payments. That’s where the risk is. But for the next three years, the risk is minimal because interest rates back then were higher.

Bipan Rai: I think in your note, you also quoted the fact that originations mortgage originations rose by a cumulative 30 percent in 2020 and twenty twenty one. So. Yes, that’s the segment that needs to understand the read that there are risks in another five years and they do need to renew. My next question to you, Benny. And again, you did kind of allude to this earlier sales in 2022 relative to twenty twenty one, which. Segment of the market, do you think, might see the most amount of risks?

Benjamin Tal: Yeah. So first of all, if you look at overall sales, I suggested that before the crisis it was about forty thousand. It went to 70. Now it’s about fifty fifty two and accelerating because people are getting into the market and try to take advantage of extremely low interest rates before it’s so low. So over the next few months, you will see fifty five sixty thousand because it will accelerate and then in the second half it will go back to maybe 40. So we see actually sales going down by about 10 percent for twenty twenty two years old, originations down by about 15 percent in terms of mortgages, which means that mortgage outstanding will go down from about eight percent, nine percent to about five point five percent. That’s a reasonable scenario, a market that will be slowing down mostly in the second half of the year. Let’s call it after the spring market. That’s basically what we see a slowing market, but not a crushing market in this environment. I believe that low rise will underperform. It’s not that they are going to go down in price, but I think that they will not rise as quickly as the condo market. Overall, I will not be surprised if prices in Canada in twenty twenty two will be rising by, let’s say, four or five percent nothing in the sky but not negative. But the pioneer will be really high rise due to the fact that they are more affordable and there is higher demand for them at this point.

Bipan Rai: Now we also know that Canadian households are amongst the most leveraged in the developed world, and I think you’ve made this point several times before a rate hike in Canada is put simply worth more than it is in most other places where you see a little less or a lot less leverage in the household sector. I mean, how does the increase in debt servicing costs affect household and the affordability of the housing market itself?

Benjamin Tal: Yes, that’s that’s a very good question. So first of all, we have to ask the following question what what is the fear is the fear that everybody will be defaulting on the debt. That’s not going to be the case because we have stress test. We still stress testing people at about 200 basis points higher than the actual rate. So that’s something that will continue to protect the market when it comes to risk of default and higher delinquency. Yes, some people at the margin will, but that will not be a wave. So the impact is going to be on the consumer and how much people will be spending on servicing your debt as opposed to consuming. And that’s something that can have a significant impact. And therefore looking at people who are renewing is so important. And for the first few years, we have some immunity, at least for the first 100 basis points, and that’s very important in terms of consumer spending. However, it also means that the housing market in general will slow down because newcomers to the market will not be able to deal with it, and therefore there will be a reduction in demand for housing, which is a very important contributor to economic activity. And therefore this sensitivity to higher rates is very, very important and you are absolutely right relative to other countries, we are much more sensitive. But the point that I’m making is that maybe the increased sensitivity to higher rates will prevent interest rates from rising to the sky. So the disease is also the cure. And therefore we don’t see a situation in which the bank rate will go more than two to twenty five and stabilise there, and that will be more than sufficient to slow down the market.

Bipan Rai: Good points there. So I’m going to ask you the question that we all get asked at a dinner party when it comes to the housing market. Will we ever see that corrective move that so many have been predicting for so long now? And why or why not? And what causes that move when it does eventually come?

Benjamin Tal: Yeah, this is not a market that is in a bubble situation. This is not a bubble. And as long as interest rates go up in a normal way, it’s not a market that will crash. There are some vulnerabilities. No question about it. I believe that over the past year, we have seen more and more investors entering the market. And until now, those investors were not speculators, but they see more and more speculation is happening in the market. That’s risky at the margin. We are going to see more supply coming to the market because the government for the first time is actually talking about supply and going to do something about it. So that’s something that will lower the ability of this market to continue to grow in a very significant way. So what I suggest is that the number one risk facing this market. I will repeat it is a monetary policy error. Namely, a situation in which higher interest rates will lead to a recession and therefore will crash the housing market if you allow interest rates to go back to normal and just allow a mild recession as opposed to a severe recession. This market can take it. It might go down by 10 percent, but it will not crash because the fundamentals are there. One example is immigration. As I suggested, four hundred thousand in twenty twenty one, we are getting four hundred thousand new immigrants. That’s a huge number in the middle of a pandemic. That number will continue to grow. So the short answer to your question is this is not a crazy market by any stretch of the imagination. Policy errors can derail it. But if you go back to a normally functioning economy, this market can adjust but not correct in a very significant way.

Bipan Rai: Benny, always a pleasure. Thank you so very much for joining us today. We’d love to have you back sometime soon.

Benjamin Tal: A pleasure. Thank you.

Bipan Rai: Thank you, everyone for joining us for this edition of The FX Factor podcast. We’ll be back in a few weeks with another episode. Thank you very much.

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