September 11, 2020 | 14:01
Betting Against the House? Canadian Real Estate Through the Pandemic
Betting Against the House? Canadian Real Estate Through the Pandemic
Anyone expecting even a modest contraction in Canadian home prices as a result of COVID-19 has been sorely offside. After a pause in activity at the height of the pandemic in the spring, the market opened up hot in most major cities, and has only seen the temperature rise through the summer. Here’s a look at why residential real estate has performed uncharacteristically well through the downturn, and some questions about what lies ahead.
In Toronto, sales were up a hefty 40.3% from quite normal year-ago levels in August, the strongest month on record after seasonal adjustment. In Vancouver, sales jumped 36.6% y/y, with the level of activity now pushing to the highest since late-2017—recall that market was soggy heading into COVID. Montreal sales topped both, up 47% y/y. To be sure, listings are coming back onto the market at a solid clip, but not nearly fast enough to satiate heated demand. Prices in Toronto are up more than 11% from a year ago (Chart 1); Vancouver is up 5.3% (best since 2017); and, the median single-family price in Montreal was up a hefty 24%. In some markets like the Prairies, however, the re-opening has been much more subdued.
Part of the surge in activity simply reflects pent-up demand after the market was closed for about three months during prime buying season. That said, the bigger picture still suggests that there is more going on as well. First, demand-side factors are surprisingly supportive. While broad Canadian employment was still down almost 6% from pre-COVID levels in August, the declines are typically deeper in lower-paying industries (Chart 2). That is not where the typical home-buying demographic resides, especially for the mid-to-higher end of the market where there has been a lot of strength. All the while, sub-2% five-year fixed-rate mortgages have been readily available for the first time.
Meantime, preferences have shifted in response to the new normal, leading to a spike in demand for more spacious homes on larger lots, sometimes well outside the core of the major cities. The shift to work-from-home has opened up markets that were never previously in the realm of possibility for those commuting. In Toronto, for example, condo sales in the 416 were up ‘just’ 9.2% y/y in August vs. a 50.6% increase in broader detached homes across the 416 and 905. Also, the strongest year-over-year price gain (+18%) was in a region about 1-to-2 hours northwest of the city. The anecdotes about booming rural markets have been aplenty; and now, there’s some supportive data, too.
Even in the hard-hit areas of the job market, massive federal benefit programs have held up, or even lifted, disposable incomes. In fact, household net disposable income actually rose sharply in 2020Q2, as the increase in federal transfers and various tax deferrals more than offset the decline in primary income, and actually led to a record increase in real net household disposable income—in a recession no less (Chart 3). Interestingly, this has actually pulled down the closely-scrutinized household debt-to-disposable income ratio (Chart 4). Not because borrowing has slowed—consumer credit has contracted, but residential mortgage credit has accelerated—but because the historic transfer of income from the federal government to households has sharply lifted the denominator. For now.
With all that in mind, there are plenty of questions on how the market will evolve from here.
Sales and prices: Pent-up demand will likely run through the fall. Underlying resale demand was settling in to a run rate of about 42,000 units per month nationally (seasonally adjusted) just before COVID hit. Assuming that underlying demand didn’t change much (with offsetting negatives and positives), even after very strong sales levels in July and August, there’s still almost 20,000 units to make up in excess of that run rate (Chart 5). In other words, we would still need a few more months of record sales activity in order to just fill in the pandemic hole. And, if listings can’t keep up, you can bet that the recent run in prices has more room to go, especially in some smaller markets peripheral to the major cities that are now subject to a feeding frenzy.
Interest rates: Record low mortgage rates are here to stay, with the Bank of Canada arguing that the economy “will continue to require extraordinary monetary policy support” until excess capacity is absorbed—we judge rate hikes won’t even be in the conversation until 2023.
Federal support: The flagship CERB was extended for another four weeks, to 28 weeks, but will wind down for most in 2020Q4. That will be replaced with the CRB and a modified (i.e., more generous) EI program for another 26 weeks that will take us into 2021Q2. At that point, federal fiscal policy could evolve further, but suffice it to say that Ottawa is spending everything it can to prevent a serious income cliff for those that moved onto support programs earlier in the pandemic.
Mortgage deferrals: Deferrals are also about to wind down, and the first-wave of six-month deferrals should begin to run their course this month, though some have already resumed payment. OSFI has begun to phase out special capital treatment that allowed banks to report deferred mortgages as performing loans. As of September, newly-deferred mortgages will see that treatment period scaled down to three months; with a return to normal rules by October. CMHC has estimated that about 14% of mortgages were in deferral as of late-August, and the bulk of those will presumably be restarted in 2020Q4.
But, it’s very unclear how many of those deferrals will fall into arrears. The job market continues to recover, and many that deferred likely took the option as a precautionary measure, rather than out of necessity. Padded savings, credit lines and ongoing government support should help. There will not be a sudden payment shock either, as missed principal and interest will, in most cases, be tacked back onto the outstanding balance and re-amortized. And, anyone that does reach the point of having to sell will likely do so in a tight market—at least in most major cities. All told, delinquencies will indeed likely tick up in 2020Q4, but the move could be more modest than many fear. For some perspective, even through the worst of the financial crisis and deep market troubles of the early-1990s, Canadian mortgages in arrears have never pushed much above 1% (Chart 6).
New supply: Housing starts jumped to the highest level since 2007 in August, led by a surge in Ontario. Similar to sales, builders are making up for lost time (less than in the resale market), and the year-to-date average is now roughly in line with year-ago levels. New construction will likely calm down later in the year once the backlog of new projects is cleared, and potentially weaker demographic flows come into view (immigration was down 44% y/y through June, with the recovery still uncertain). On the resale side, we continue to believe that most of the new listings will come at the lower end of the market and in the urban condo space. On the latter, investment fundamentals were already stretched pre-COVID with most buyers cash flow negative. Now, with rents under some pressure, vacancies potentially ticking up and a less robust short-term rental market, we could see some offloading over time.
The Bottom Line: The residential real estate market has essentially laughed in the face of the bears, sailing through the pandemic on the back of record-low mortgage rates, job-market dynamics, massive federal support and a dearth of resale listings. In some markets, the near-term risk might even be tilted toward excessive strength rather than serious weakness. Longer-term challenges will certainly dampen some markets/segments once the initial post-pandemic rush fades, but the more significant concern is in pockets of commercial real estate.