Focus
May 01, 2020 | 14:51
Canadian Real Estate: Closed Until Further Notice
Economics
Economics
Economics
Economics
Economics
Economics
Fixed Income Strategy
Economics
Economics
Economics
Economics
Economics
Economics
Fixed Income Strategy
Canadian Real Estate: Closed Until Further Notice |
|
The Canadian real estate market is in the midst of a shock without any historical precedent. Canadian existing home sales fell 14.3% in seasonally-adjusted terms in March, the biggest monthly decline since late-2008. In the first half of the month, the market (and especially the three biggest cities) was priming for a charged run. But the second half of the month saw activity shut in by the COVID-19 outbreak. As a result, the April numbers, which will start to roll out from the big cities next week, will be substantially weaker still. Early estimates suggest declines of roughly 60%-to-70% y/y across many cities. Importantly, new listings have plunged at roughly the same pace, so the deterioration in prices should be contained for now. Over the medium term, however, the ‘new normal’ could re-shape some segments of the market. Residential DemandInterest rates: The biggest immediate support will come from the plunge in long-term interest rates, and the Bank of Canada’s move to the effective lower bound. Five-year fixed rate mortgages are available in the 2.4%-to-2.6% range, down about 50 bps from a year ago and matching historic lows. This will support demand as the economy re-opens, and we don’t believe Bank of Canada rate hikes are on the horizon until 2022. |
Job market: The severity of the downturn is well understood, but the length and pace of the recovery are major uncertainties. A handful of provinces are gradually re-opening their economies, led by Quebec, with some of the smaller provinces also on the move. Still, the Canadian jobless rate is expected to hover in double digits in 2020Q2, before finishing the year above 7%—that's a material shock for housing, however you spin it. What’s interesting is that, at least in the March data (which were still early days), the extreme jobless rate damage was in sectors such as accommodation, restaurants and retail (Chart 1). Education is high on the list, too, but teachers are still getting paid. So far, layoffs have been less severe in finance, professional services and the public sector. If weakness is more concentrated in lower-paying industries, while higher-paying positions are relatively protected, it could also fragment the housing market impact—that is, a bigger impact on renters, for now. Presumably, massive federal income support and mortgage deferral programs will help keep homeowners in their homes, limiting forced selling, and keeping rent payments flowing. But the economy and jobs will need to come back on the timeline expected. |
| Immigration: Net international inflows surged to 488k people in 2019 (Chart 2), a major boost to housing demand, for both ownership and rental units. In the U.S., an executive order has suspended some permanent resident applications for at least 60 days. To date, there has been no such action in Canada with immigration draws reportedly still ongoing, and those with previously-granted status exempt from travel restrictions. But, the post-COVID environment could have longer-term implications on the movement of labour globally, which could impact non-permanent resident numbers that have recently surged in Canada. That would disproportionately hit rental-market demand. And, until international travel resumes, foreign investment activity could be on hold. Urban vs. suburban/rural: Rural locations could draw increased interest for a few reasons. First, the move toward remote work could open up an affordability valve by allowing households to settle beyond commuter-friendly (and increasingly expensive) locations. Also, densification has been the norm in many regions over the past decade, but the current experience could alter preferences, placing more value on large lots and rural settings. This shift would likely be incremental, but noticeable for smaller communities. Residential SupplyHousing starts: New construction activity is ongoing in most markets, with precautions in place. Ontario has halted new projects without permits in place, but those underway are moving toward completion. Quebec, which was stricter at the outset, will allow construction to resume May 11th. Overall, while there will be a temporary lull in activity, we judge housing starts will still average a solid 185k units in 2020 versus 209k last year (Chart 3). The impact on new housing supply shouldn’t be enough to severely distort the market. Resale listings: The behavior of new listings is what will make this shock unique and, to date, the market has effectively frozen itself in time. That is, new listings are plunging in line with sales given the nature of the shutdown (Chart 4). Contrast that to 2008/09, when sales fell by almost 40% from the end of 2007 to the 2009 lows, but new listings rose by 15% through the early stages of that period—that’s how you get a quick and meaningful decline in prices. We suspect that sales and listings could both come back in rapid fashion, leaving broad prices steady through this challenging period. |
|
Investment stock: If the current environment persists longer than expected, investors could be pressured. Federal support measures should keep rent payments flowing to landlords, preventing a wave of selling. But, the appetite for the asset class could be tempered going forward, especially with cap rates already tight and cash flow negative in most markets, even at record low mortgage rates. Additionally, with travel likely on hold for a prolonged period, short-term rental properties will need to be reallocated (to personal use or onto the long-term market, if possible) or sold. Recent municipal rule changes have already started to crowd out this sector somewhat, but the pace is about to accelerate sharply. One study from McGill University suggests that 30,000 units were pulled off the long-term rental market because of Airbnb alone, while the Hotel Association of Canada (although with an obvious agenda) found more than 100,000 units on the Airbnb platform. All told, these factors could ease policymakers’ concern about a lack of rental supply, but could pressure investors, particularly in the condo space. |
Commercial Real EstateThe Main Street commercial segment is in distress, with shops, restaurants and personal services shut down across most of the country. The Canada Emergency Commercial Rent Assistance program will cover rent and help keep these small businesses solvent through June. The program seeks to allocate the burden: 50% to the government, 25% tenant and 25% to the landlord. While commendable, it comes with the usual procedural hurdles, and somewhat late in the game—most tenants are already two rent payments in. |
Longer term, the commercial real estate sector could be reshaped by larger post-COVID trends, creating challenges in some segments, but opportunities in others. In the office segment, adoption of remote work, even on a rotating basis, will open up more vacancies. While this represents a cost-cutting opportunity for some firms, landlords and office-oriented REITs could see rents pressured. But, perhaps running counter to that trend, there will also be a move to provide spacing between workers, at least for the time being. On the flip side, online shopping will continue to drive demand for industrial and warehouse space. Cap rates in the industrial sector had compressed to record-low levels before the shock, according to CBRE, and sat below retail cap rates by the widest margin ever (Chart 5). |
|
The latter will continue to be pressured upward. As an illustration, employment in wholesale trade, transportation and warehousing has grown at twice the rate of that in traditional retail over the past decade in Canada. The Bottom Line: This is anything but a normal shock for the Canadian real estate market, and much of the outcome will be dictated by how quickly and sustainably economic restrictions can be eased. In the best case scenario, the market will be functioning again by late-summer and the fall season could be very active—albeit operating in a world of distancing—with plenty of pent-up demand. But, longer lockdowns would only make the economic damage more permanent, raising more serious consequences for home prices and solvency. Longer term, some fundamental shifts in investment appetite could result. |