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CIBC World Markets Inc.
Economic Insights—June 25, 2015
The Many Faces of the Canadian Housing Market
Benjamin Tal and Andrew Grantham
In meetings we are often asked to make a brief statement
regarding real estate in Canada. The reality is that the
only brief statement we can make about real estate is
that we cannot make a brief statement about real estate.
It is a multi-dimensional market and a blanket statement
will not do.
and Toronto have if anything accelerated since the start
of the year. So looking at the example of individual cities,
there’s ammunition for both bulls and bears alike with
regards to the overall market.
Examining the rest of the market combined, it appears
that price growth has slowed and is now more or less
Below we discuss some of the dimensions that are most in line with the target rate of inflation. For CMA’s less
relevant today. We examine the market in absolute terms Toronto, Calgary and Vancouver, prices are around
as opposed to the popular practice of comparing it to 2% higher than at this point last year. Earlier on in the
the pre-recession US. The focus is on the characteristics recovery we were looking at figures closer to 4% (Chart
that make the Canadian market unique and multi- 1). So those markets are a living proof that there is such
dimensional.
a thing as a soft landing in real estate. Another glance
at Chart 1 and it also appears that housing markets
Geography: Truths, Lies and Averages
elsewhere in the country aren’t impacted by booms or
busts seen in the big markets of Toronto, Vancouver or
Averages can mask a lot of things. Provincially and Calgary.
even at the city level, very different trends are occurring
within the housing market that makes using a blanket Robust increases in cities with already above-average
national average useless. As the economies of commodity prices works to bias upward the widely quoted average
producing provinces are being hit by lower oil prices, national house price. As such the ratio of the simple
housing sales and prices are also turning downwards. For average price measure and the weighted price measure
example, a steady uptrend in Calgary house prices since (which compensates for changes in provincial activity
the end of the recession came to an end late last year, and by taking into account the provincial proportion of the
prices have now started to move downwards prompting privately owned housing stock) is at an eight-year high.
concerns of a hard landing for that market.
Demographics: Dangerous or Dependable?
But, aided by even lower interest rates, other high-flying
housing markets aren’t seeing any sort of landing yet. In One reason why it’s unwise to compare the Canadian
fact, the annual rates of house price growth in Vancouver housing market of today to the US market before it
crashed is that, unlike the situation stateside, there
isn’t anywhere near the same degree of overbuilding in
Chart 1
Canada relative to household formation. In fact, the ratio
A Tale of Two Markets
of housing starts to household formation is not far from
its long-run average of 1.03.
Weighted Average Price
14.0
y/y % chg, 3-mo moving avg
There are some markets that have seen more aggressive
construction activity than household formation, with
Ontario, Alberta and BC all recently seeing rates of
homebuilding that have outstripped by a narrow margin
what normal demographics would dictate. However, the
current trend in major cities within those areas is not
uniform, with the Calgary market seeing a hit to activity
as the repercussions of lower oil prices spread.
12.0
10.0
8.0
6.0
4.0
2.0
0.0
11
12
13
14
15
All CMAs Less Toronto, Calgary and Vancouver
Toronto and Vancouver
Source: CREA, CIBC
What has limited dramatic overbuilding in those centres
is immigration. The three largest cities take in roughly
8
CIBC World Markets Inc.
Economic Insights—June 25, 2015
In these areas, high rise condo developments have in
many ways acted as an important substitute to the low
rise sector. Due to land availability and other factors, the
number of single & semi-detached homes being built in
Toronto has remained extremely low since the recession.
Chart 2
Canada’s Prime-aged Population Growth Has Been
Better Than OECD Aggregate, US
0.30
0.25
101
0.20
0.15
100
99
And the condo market has also helped introduce an
element of affordability into the market, helping first
time buyers. Due to the lack of availability in the low
rise market, particularly in already highly concentrated
centres such as Toronto and Vancouver, prices of already
expensive homes have been rising faster than prices in
low and mid-range brackets3. That limited the ability
of many homeowners to move-up, and supported
renovation activity with smaller homes being made bigger
through additions and extensions. But it’s also meant that
first time buyers, who do not have the income or downpayment to afford their dream home yet, are increasingly
turning to condo units. In this sense the condo market
is acting as a stabilizing, rather than destabilizing, force
on the market as a whole. But is it too much of a good
thing? The answer lies within the rental market.
0.10
00
12
0.05
OECD Aggregate
Canada
0.00
03
06
09
Canada
USA
Source: OECD, Various National Statistical Offices, StatsCan, CIBC
half of all new immigrants into Canada. That means they
are disproportionately benefiting from a demographic
boost that new Canadians are providing. Immigration
has accounted for around three-quarters of population
growth in Canada recently, and crucially for the housing
market a greater proportion of those new immigrants
have been of prime home-buying age than in the past.
Around half of recent new immigrants are aged between
25 and 45. In fact, over the past three years the number
of Canadians aged 20-44 rose by an average annual rate
of more than 1.1%—the fastest pace in more than two
decades, but also much stronger than the average OECD
rate. Over the past decade, the number of these primeage Canadians has risen 75% faster than those in the US
(Chart 2)1.
Rent: If You Build It Will They Come?
Condos have also been acting as an important
counterbalance in the rental market in Canada’s major
cities. In recent years, the proportion of condos made
available to rent has steadily increased. But rather than
a disturbing trend suggesting that private investors are
being overly optimistic regarding the safety of housing,
it helped offset a very subdued trend in purpose-built
apartment buildings. Between 2007-2014, within the
GTA, for example, almost all of the growth in available
rental units came from condo rentals.
And the demographic story does not end here. In addition
to new immigrants, Canada is home to no less than
770,000 non-permanent residents (NPRs). In fact, this
category accounted for all the growth in the important
age group of 25-44 since 2006. And not all of those NPRs
are represented in official statistics. Based on information
obtained from Citizenship and Immigration Canada (CIC)
we estimate that the number of non-permanent residents
could be under-represented in Statistics Canada’s
population projections by as much as 200K—representing
unaccounted demand for housing2.
Chart 3
Rising Propensity To Rent: A Trend For All Ages
32.0
31.5
Composition: Does the Mix Need a Fix?
Toronto
%
50
30.5
40
30.0
30
29.5
20
9
2009
2014
10
28.5
28.0
By Age
%
60
31.0
29.0
But surely the sheer number of cranes in major cities such
as Toronto and Vancouver is a sign that overbuilding is rife
in these key areas? Here we have to proceed carefully. 70
0
09 10 11 12 13 14
65+
102
%
55-64
0.35
45-54
0.40
103
35-44
Index 2000=100
25-34
104
Average Annual Increase,
Past Decade
18-25
20-44 Population
Source: Financial Monitor, CIBC
CIBC World Markets Inc.
Economic Insights—June 25, 2015
And that’s been important to satisfy demand. Given rising
house prices, the propensity to rent rather than own a
home has increased across age bands in the city (Chart
3). And the important influence of new immigrants on
population growth in major cities has also helped to
ensure that demand was strong in the years following
the recession.
years. CMHC estimates that just under 20% of the stock
of condo units in Toronto and Vancouver are owned by
investors, but when it comes to the flow of investment
activity, we estimate that roughly 70% of pre-sales
and 50% of final sales are to investors. Now, not all
investors are the same. The issue of foreign investors is
largely misunderstood. The share of those investors in
total activity is much smaller than perceived. The more
significant portion is coming from a situation in which
the money is coming from abroad but the family lives in
Canada. Is that foreign or domestic investment? Note that
this kind of activity requires much larger down payment
and the fact that the family lives in the house suggests a
much higher level of commitment than a typical investor.
So in terms of risk, this segment of the market is relatively
safe.
However, demand for rental units in Toronto may now
be moderating, and this is coming at a time when the
supply of rental units is rising strongly. Even with a
higher propensity to rent among age groups, shifting
demographics mean that the annual increase in demand
for rental units likely peaked in 2012 and is now slowly
moderating (Chart 4). Based on demographics, we
estimate that demand for rental units in the GTA will
average 12,000 a year in 2015 and 2016. And that
could fall a little short of upcoming supply. According to
different sources we estimate that the supply of rental
condo units will top an annual average of 14,000 units
in 2015 and 2016 – suggesting excess supply of just over
2,000 units a year. And there are already signs that the
rental market is cooling down. The lease-to-listing ratio
has fallen to 64.3%, from 70% a year ago. And we see
a clear moderation in rent inflation to almost zero on a
year-over-year basis. The moderation in rent and increase
in vacancy rate could well continue throughout this year
and into 2016.
What about domestic investors? If in the past many of
them bought condo units as speculators that is clearly
not the case now. The pace of price increase in the condo
market is hardly impressive with most of the increase
in average price in cities like Toronto and Vancouver
coming from the low-rise segment of the market. So
capital appreciation is becoming less of a motivation.
Capital preservation and rent income are currently the
main motivation for investment activity. And that’s where
the vulnerability is. We estimate that roughly half of the
stock of rental units in the cities belong to this category.
To the extent that higher rates and/or low rent inflation
challenge the economics of rent, we might see a wave of
sales in the resale market that will directly compete with
the upcoming influx of new units.
Investors: What Are They Thinking?
That moderation in rent inflation and the eventual
increase in borrowing cost is probably the most significant
challenge that will face the condo market in the coming
What might limit the damage here is the fact that the
affordability issue will work to increase condo buying by
young families and the propensity to rent (hence increase
the demand for rental units). The clear understating of
the impact of non-permanent residents on rental demand
might also work as an offsetting factor.
Chart 4
Rental Demand Set to Ease (L), Falling Short of
Upcoming Supply R)
Demographically Driven
Demand for Rental
Units - Toronto
16,000
16000
But regardless of the near-term trajectory, it is becoming
clear that the condo market has reached a point in which
some decisions have to be made. Until now the condo
market was the only player in the rental market with
very little new competition from purpose built activity.
This is now changing. With some condo sites reaching
$3 per square foot (a threshold that is largely believed to
convert a condo project to a purpose built project) many
institutional players are slowly entering the purpose-built
apartment space. Given these trends, we might see a
notable increase in rental purpose built supply starting
in 2017.
units
14000
12000
14,000
10000
12,000
8000
6000
10,000
4000
8,000
6,000
Average 2015-2016:
Toronto
2000
0
04 06 08 10 12 14 16
Supply
Demand
Source: Statistics Canada, CMHC, CIBC
10
CIBC World Markets Inc.
Economic Insights—June 25, 2015
The extent to which purpose built will compete or
compliment condo activity will largely impact the
trajectories of those markets in the coming years. That is,
to what extent the condo and the purpose built players
will target the same market, or one (say condos) will
continue to focus on small units while the other (purpose
built) may go for larger units—aimed at growing young
families and downsizing baby-boomers.
on major financial institutions combined with even lower
mortgage rates may work to widen those shadowy
margins5.
Summing Up
We purposely did not compare the current situation
in Canada to the US market in 2006. That would be
setting the bar too low. Comparing Canada to the precrisis US market is not only wrong but also irresponsible.
And looking at Canada in absolute terms reveals a
multidimensional market and differing directions at
the same time. Even a multidimensional market can
overshoot, and the reality is that the market has not
been tested yet. Higher interest rates will expose some
weaknesses that are now well hidden.
Credit Risk: Quality as Well as Quantity
For the wider market, the real test will come when
interest rates start to rise, whenever that may be. But
even that day of reckoning may not be as painful as some
fear, due to the steps taken by Canadian households
in recent years. An estimated 30-40% of households
with mortgages now accelerate payments in a way
that de-facto shortens their amortization. And they are
paying back an estimated $11bn a year more in principal
payments than officially estimated.
The lack of supply of low rise housing in places such
as Toronto and Vancouver suggests that most of the
adjustment will be felt in the high-rise segment of the
market. Excess supply of condo units in Toronto along
with potential increases in resale activity by domestic
condo investors in a reaction to higher borrowing cost
suggests that this market will slowdown in the coming
years. The magnitude and speed of such adjustment
will be in large a function of the degree of integration
and coordination between condo rental activity and the
upcoming increased supply of purpose built projects.
Higher interest rates probably will not lead to a wave of
defaults as feared by many, but could act as a major drag
on overall economic activity via the impact on consumer
spending (as more income is devoted to servicing debt)
and the potentially significant impact on job creation in
real estate-related sectors.
Of course, what looks good on average does not always
look as good at the margin—where losses actually occur.
However, even here there’s little evidence of impending
weakness. The share of mortgages with loan-to-value
(LTV) larger than 80% has, in fact, fallen since 2009. At
6%, the proportion of households allocating more than
40% of their income to debt financing has remained
relatively stable and the average credit score has trended
upward over the past five years, with all regions and age
groups seeing improvement4.
Nevertheless, the system is not perfect. The increased
regulatory requirements on major lenders is leading to
increased activity in the less/non regulated segment of
the market as we see increased transfer of risk from large
financial institutions to alternative lenders. This is not a
zero sum game—as the risk profile in the industry as a
whole is on the rise.
The market will adjust, but given the many faces of the
market, the adjustment will not be uniform. It will impact
different segments at different intensity, and therefore on
aggregate be smoother and take longer to fully unload.
But how significant is that risk? We utilize three different
measures aimed at assessing alternative/non-prime
lending in the Canadian mortgage space. Information
from Revenue Canada (via Statistics Canada), from
CMHC, via its securitization database, and most
importantly, from the Teranet mortgage registration
database, enables us to classify mortgage originations by
type of lenders and actual mortgage rates. The bottom
line is that regardless of how you measure it, alternative/
non-prime lending, while rising fast, is still an extremely
small portion of total mortgage activity in Canada—
probably smaller than perceived by many. That is not to
suggest that the system is risk free. Increased regulations
Note :
11
1)
Foundations of Canadian Housing Better Than Advertised
(Economic Insights, Nov 19, 2014)
2)
Non-Permanent Residents—A Major Demographic Force
(Economic Insights, April 29, 2015)
3)
Staying Put (In Focus, September 8, 2014)
4)
Resisting Tempation (Economic Insights, Oct 15, 2014)
5)
How Shadowy is Mortgage Lending in Canada? (In Focus,
February 18, 2015)