Greater risk in Canadian housing markets remaining hot than cooling down: TD
TD Bank Financial Group released a “Resale Housing Outlook” yesterday that provides some insights into the potential consequences of the quick recovery that the Canadian housing market experienced over the past year. It’s a pretty interesting, “where we’ve been, where we may be headed” report. Some of the ideas that caught my attention from the report are outlined below. The full five-page report can be found here.
While in the thick of a recession, the strongest countervailing force that set the stage for the mother of all rebounds, apart from lower prices, was lower interest rates.
All said, the housing market has gone beyond retracing its steps and fully recovering from the end of 2007 – which had marked the peak of a half-decade long boom, concentrated in Western Canada…As of October, both sales and the average price stood 5% higher than their respective 2007 peak…But now that home values are already past their previous peak in such short order, we estimate that the typical home remains overvalued by 12% at the national level. Unfortunately, sheer momentum suggests that this overvaluation is likely to increase over the course of the next few quarters, peaking at 13-15% in H1/2010.
The misalignment of home prices with their fundamental drivers, such as demographics and income, cannot last. That much is known…Because a necessary realignment has been erased so quickly without support from income growth, another adjustment must take place – although it could take many forms. As of our writing this note, early signs of market cooling are emerging and our analysis still suggests the most likely outcome is a soft landing and relative stagnation of home values in real-terms along with a resumption of stronger income growth over the 2011-13 time frame.
As the central bank begins to hint at a tightening monetary policy cycle in the second half of next year, sales could well see a last gasp of strength. Moreover, by that time, the availability of units on the supply side should provide a relief valve helping to cool price growth. And, by 2011, while the overall economy will have improved significantly, housing markets will be losing momentum.
While current price levels are above what we estimate to be long run fundamental values, they do not appear so dramatically out of line as to warrant a sharp correction in the near-term…As for price momentum, it is more clearly unsustainable…Recall that every price increase that is not matched by a commensurate income gain increases the overvaluation gap. Second, more supply should come online in the first half of 2010 in the form of new home and condo completions.
The current market tightness, as measured by the sales-to-listings ratio (limited inventory), while expected to ease gradually over the course of 2010, will not turn on a dime. As a consequence, it will be supportive of price growth in 2010 that is stronger than fundamentals can support over the long haul. After climbing by an estimated 4-5% on an annual basis this year, the average existing home price is expected to gain another 9-10% in 2010 as sales climb to 475K.
In closing, we note that the most important downside risk to our near-term forecast is not that the market cools more than we anticipate. While this risk certainly exists, it would not cause significant market disruptions, and it would ensure that affordability does not continue to erode at the current pace. The risk is rather that the market remains as hot as it currently is for too long, eventually running head-on into monetary policy tightening (and longer term bond yields rising). There is more than adequate time for the housing market to cool before then, but history suggests that if it fails to do so, the ensuing adjustment would be a rude awakening.
Thanks to Larry Yatkowsky of Vancouver’s Yatter Matters for the heads up on this report. See Larry’s overview, “Green Chair Talks.”
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Norm Fisher
Royal LePage Saskatoon Real Estate
There's 15 Comments So Far
December 2nd, 2009 at 10:38 am
While current price levels are above what we estimate to be long run fundamental values, they do not appear so dramatically out of line as to warrant a sharp correction in the near-term…
‘Not so dramatically out of line’?? The ratio of ‘average house’ to ‘average income’ across Canada is approximately 5.4 … where 3.5 has been considered ‘historically affordable’. In some heavily-bubbled places like Vancouver or Toronto it is significantly higher — between 7 and 8. How is that not ‘dramatically out of line’? Or have the rules changed when I wasn’t looking?
I have been very glad to see that the recent mania (prices going up instead of down) has not impacted the Saskatoon market in the same way as it has in some places, but I still refer to my ‘carrying cost vs. actual cost’ argument … I think that people are only looking at what the mortgage will cost this month and not how much it actually is. Humans are (on the whole) very short-sighted creatures…
December 2nd, 2009 at 11:18 am
Bookrat,
Good points, but it’s been a helluva long time since real estate prices have been 3.5 times income in Vancouver or Toronto so clearly, in some markets higher prices have proven to be sustainable. Not saying that’s right, just that it is the way it is.
I am also pleased that our market hasn’t gone completely crazy in terms of further price inflation. Still, we’re probably in the 4.5-5 times median household income range. On the other hand, it’s does feel somewhat better to be 20% below the national average.
December 2nd, 2009 at 7:06 pm
“so clearly, in some markets higher prices have proven to be sustainable”
I think Norm hit the nail squarely on the head. I keep hearing again and again that the market just HAS to crash. You could very well see stagnant or slowly rising prices while inflation eats away at the excess. If you want to say prices are unreasonable or that it’s unfair to new buyers I can accept that but please do not lead people astray by asserting that prices are guaranteed to fall.
December 3rd, 2009 at 2:54 am
Sustainable = More income Need to offset int. rate increase and cost of living. Suspect is that there will be a lot of labor upheaval post Olympics when all the infrastructure projects dry up. Sorry don’t have any labor stats to rationalize that – just gut feeling.
December 3rd, 2009 at 6:38 am
Good points Larry. To be clear, I don’t mean to imply that current prices are “sustainable” or not, simply that prices above 3.5 times income seem to have been sustained in many areas for quite a long time. I also recognize that to some extent rising prices make that a lot easier than flat or declining prices would.
Peter, I don’t think Bookrat was “guaranteeing” that prices would fall, but rather, disagreeing with the TD economist’s comment that prices aren’t “dramatically out of line.” Using 3.5 times incomes as the measuring stick would certainly put them very high almost everywhere.
December 4th, 2009 at 9:02 am
Regarding Norm’s recent tweet: In an unexpected spate of good news, unemployment fell on both sides of the border:
Payrolls in U.S. Decline 11,000; Unemployment at 10%
“unemployment rate dipped to 8.5 per cent from 8.6 per cent as both full-time and part-time jobs rose and the number of self-employed Canadians declined”
Here is more specific information from StatsCan :
Unemployment in SK fell by 1.7% month-over-month, but is still up by 39.7% year over year. It looks like more full-time rather than part-time jobs were created too, which is certainly a good thing.
December 4th, 2009 at 2:07 pm
Jen, agreed, but I think it’s still early to tell if we’re truly exiting this recession – or this is merely a respite before a gradual slide into another one (the stimulus has almost run its course). The real US unemployment rate is actually closer to 22%. If the economy is improving, interest rates are sure to rise; if not, we’ll probably see a more prolonged period of lower rates.
December 4th, 2009 at 2:33 pm
Sensible Jason,
You make some excellent points, particularly about the withdrawl of the stimulus. It’s good to see that we’re doing much better than our southern neighbor, but our economies are inextricably linked, for sure. I have to admit I am more heartened by this data than the GDP data, at any rate.
December 4th, 2009 at 6:16 pm
Jen, public sector growth was 54,000; private 25,000. 53,300 of the jobs created were in education (37.9k), health care (4.1k) or public administration (11.3k). Stimulus?
December 4th, 2009 at 7:38 pm
Norm,
In this particular post, he may not have been but I have seen comments time and again insisting that prices have to fall.
Jason,
I am not sure which stimulus you are speaking of but I can tell you that the US stimulus is actually only 25-30% spent right now with the spending to continue through 2010. The stimulus spending will actually be accelerating going forward.
U-6 unemployment, which I assume you are talking about is actually 17%. Where do you get 22 from?
You can hate it, deny it, spit at it and call it names but the fact of the matter is the economy is turning around.
interesting captcha: visaing FIRST
December 4th, 2009 at 8:02 pm
“In this particular post, he may not have been but I have seen comments time and again insisting that prices have to fall.”
Okay, you’ve got me there Peter.
December 4th, 2009 at 9:13 pm
Peter, in the US most of the money in the stimulus will have little to no impact on their economy. Point is, in order to utilize it, states have to spend as well, and that’s a tad hard when 24 of them are running a $15-billion deficit on unemployment coverage alone. Can’t recall where I saw the 22% the other day; if I can find the link I’ll post it.
Maybe. Maybe we’ll drop back into a recession in 2010, too. I’m saying it’s “unlikely” that we’re in a recovery (I’m not saying it’s “impossible”). In any event, I think I’ll need more data than one month of GDP growth (and that at +0.1%) to be convinced. Recovery = higher interest rates, so I’m game.
December 4th, 2009 at 9:53 pm
Peter,
Jason and I are speaking of this stimulus.
This is a direct quote from the above article:
“Eleven months after presenting his recession-fighting budget, Mr. Flaherty said in a report Wednesday that almost 60 per cent of $62-billion in federal and provincial economic stimulus measures will be spent this year, and fade out by the end of 2010.
Given the administrative delays with dispersing the money, the bulk of the stimulus made its way into the economy only over the past few months. That momentum likely will carry into the early part of next year, by which point Mr. Flaherty intends to close the taps. The minister on Wednesday set a deadline of Jan. 29, 2010, to allocate the remainder of the federal portion, and insisted that no further measures would be forthcoming.”
I believe you’re closer to the correct about the U.S. U6 unemployment number. At a practical level, though, it’s nasty any way you slice it.
Jason,
Re: the effect of said stimulus- I just don’t know. The monthly numbers can be fairly volatile. I’d sure like to see a trend, but it may take a few months to get there.
December 4th, 2009 at 11:17 pm
Jen, official (U3/U6) vs. SGS (alternate). 22%.
http://theautomaticearth.blogspot.com/2009/12/december-2-2009-its-foolish-to-ask-for.html
I don’t know the ultimate effect of the Canadian stimulus, either – other than we’ve run up a whole lot more federal, provincial and municipal debt (and this is going to have to be repaid someday). You had to spend money to receive money, so it’s kind of a vicious cycle. And when they vaguely start referencing a ’second stimulus’, that does tend to make one question about how successful the first one really was.
All I can think of is Japan… the lost decade, and how the same course we’re on didn’t work out very well for them in the end.
December 5th, 2009 at 12:42 pm
Jen / Jason
I won’t deny that there will be long-term fallout for the actions of our leaders. I am merely saying that the stimulus does seem to be working. The fact that GDP has returned to positive, unemployment numbers have started to shrink, even with stimulus, would have seemed pretty unlikely back in March. There is also a huge psychological impact to having numbers turn positive, investors and businessmen turn from being afraid of losing money to being afraid of losing out on an opportunity. Don’t underestimate that fear. Just as the deflationary cycle can feed on itself causing things to continue to worsen, so to can the upswing. Throw in ridiculously low interest rates and it becomes clear that we are in the midst of a V-shaped recovery, personally I believe it will go well into 2010 probably even 2011 before it crashes out. Yes, higher interest rates will come and yes there will be hell to pay down the road but as an investor the money to be made seems to be on the long side.
As far as housing I am going to predict that these events will lead to a very strong spring market. I think housing prices will hit record average price levels in at least 2 of march/april/may. I won’t take credit for this theory as it’s based on ideas others have postulated. There will be concern that interest rates are about to take off, dissipation of economic worries and pent-up demand should all drive the market.