Canada’s housing market demonstrated surprising resilience in the face of the pandemic with record levels of activity and prices. While the buying frenzy has calmed from extreme levels, the market continues to operate at historically high levels. How the dynamic of increasing demand, constrained supply and government intervention will play out is being closely watched by those in the real estate industry.
On this episode of The Real Pulse, Craig Wright, RBC’s Chief Economist sits down with Nurit Altman to discuss the Canadian housing market and how the supply-demand dynamics facing the sector will play out in the coming months.
- During the pandemic, the household savings rate increased to historic levels – there is now C$280 billion sitting in bank accounts. With this increased purchasing power, we expect continued strength in housing demand for the foreseeable future.
- The federal government’s immigration targets will result in over a million new immigrants over the next three years, putting additional pressure on demand for housing.
- Housing affordability will continue to be a challenge in the near term as prices continue to increase, interest rates rise and much of the strong income gains will decline – as sizeable government programs will be rolled back.
- Despite the disappointing GDP figures, we think the Bank of Canada will hold course and overnight rates will be 50 basis points higher by the end of 2022 relative to today. There is a small risk of a larger move in interest rates – if it were to happen, it will significantly hit affordability and the housing market.
- RBC’s base case scenario is for the housing market to cool, not collapse. We expect prices to flatten in the second half of 2022.
Speaker 1: This is The Real Pulse, a podcast series where RBC capital markets experts share their insights on the latest trends and opportunities in commercial real estate.
Nurit Altman: Welcome to The Real Pulse. I’m your host, Nurit Altman. The Canadian housing sector demonstrated surprising resilience in the face of the pandemic with the price of housing, not only holding up, but increasing across most Canadian markets. While the market isn’t as frenzied as it was at the start of this year, it continues to operate at historically strong levels. But with continued strong demand and extremely tight supply, affordability continues to be a key issue for Canadians who wish to own a home, as well as politicians who want to support home ownership in Canada. How the dynamic of increasing demand, constrained supply and government intervention will play out as being closely watched by those in the real estate industry. Today, I am joined by Craig Wright, Chief Economist at RBC, and we are here to talk about the housing market in Canada and discuss how the supply, demand dynamics facing the sector will play out in the coming months. Craig, thank you for joining us.
Craig Wright: My pleasure, Nurit.
Nurit Altman: Craig, I wanted to start with the demand side of the housing equation. Canadians have built up their savings during the pandemic to the tune of 280 billion sitting in Canadian bank accounts. With this increased level of purchasing power, are we going to continue to see a heated housing market for the foreseeable future?
Craig Wright: It’s a lot of tension on the demand side. And I guess the short answer to your question is yes. So you mentioned the savings of $280 billion. But if you look at the consumer generally on average, sort of where they are now relative to pre COVID levels, they’re in actually much better shape. So savings, $280 billion, excess savings. Debt to income ratio has come off its highs. It’s still elevated, but it has improved through the COVID period. And then if you look at household net worth, so this is what the households have made through equity markets and now housing markets, that’s up to two and a half trillion. Now, consumers don’t spend all of that, but if they spend even a bit of a big number like that, it all adds up to a pretty strong demand environment. So the savings we’ve seen, the equity that have been built up, that’s going to continue, we think, to support homes, home activity, it’s going to continue to support some investment, maybe condos, cottages, and the like.
Craig Wright: But also probably continue to build the bank of mom and dad, if you will, which has been increasingly a component to the strength we’re seeing in the housing market. And beyond that, some other strong demand fundamentals, the employment market was rocked pretty significantly, but that tend to be disproportionate in the low income households, which aren’t necessarily in the buying mode, if you will. So that sector, the higher income households actually didn’t see much of a decline, if any, through the COVID crisis. And now well above free COVID levels. Low interest rates, part of the story. Millennials getting into the market. And then immigration’s very aggressive targets over the next couple of years and all that has provided a fairly sizeable move in demand relative to supply, which is always a challenge to catch up.
Craig Wright: So [inaudible 00:03:08] the listing ratio, which, to your point about tight housing market, traditionally balances between 0.4, 0.6. In Canada, it’s north of 0.7 and it’s across all the major markets. So cost price pressures are there [inaudible 00:03:21] cost are rising, labor and markets challenged. So our view is that prices will continue to be strong going forward. Maybe not at the 20% plus pace we’re seeing right now, but we do see the hot housing market for the foreseeable future, but likely slightly slower price gains as we move through the course of 2022.
Nurit Altman: Craig, you mentioned immigration. The Canadian government has set some ambitious immigration targets with plans to bring over 400,000 new immigrants into the country each year. What level of annual supply will be required to provide housing to these new Canadians and will it our major markets or our secondary markets where most of that demand will be focused?
Craig Wright: When we look at the supply side, that’s been the big story for a long period of time. When you look at the challenge in the housing market, demand’s been holding up, but supply just not had the ability to keep up with that. So a lot of attention gets on demand, but I think more attention as we move forward will be shifting to the supply side to be able to get more houses to market, to support strong demand, which does include the immigration targets. The federal government for this year and the next two years, a total of 1.22 million new Canadians coming in to the economy and that’s going to contribute to continued pressure on the demand side. And if you look at a few numbers, the pre COVID household formation is about 220,000. If you add in the incremental moves on the immigration that you mentioned, plus some other components, including secondary homes, we get up about to 255,000 new requirements each and every year.
Craig Wright: And that’s going to continue to rise by our estimates to 265 over the next couple of years. So that’s going to continue to be challenged meeting demand. Now, the good news is we have seen supply, we have seen starts respond. The latest over the last 12 months, housing starts are about the highs we have not seen since 1977. So very robust starts. And starts unfortunately do take longer time to get into completions, to get to market. Over the last couple of decades that average time of completion’s moved from nine months to 21 months, which reflects the multifamily tilt that we’ve seen the housing starts. But housing starts at best in ’77, at 260,000, just over 260,000 units. That’s up 26% relative to pre COVID levels. And if you look at the rural, small that’s where we’re seeing even more aggressive. Increases there.
Craig Wright: So 50% in the rural, small, just north a 30% increase in starts relative pre COVID levels. And that in part reflects the fact that the smaller rural markets tend to be more ground oriented, which have a shorter completion cycle. So big cities are going to continue to face pressure because a longer building cycle and because many of those new immigrants into Canada will head into to those major city markets. So a bit of differentiation there. But overall supply’s done a pretty phenomenal job trying to keep up not withstanding some supply chain challenges and importantly, some shortages on the trade side.
Nurit Altman: Well, even with supply doing a phenomenal job, I think we still are experiencing a supply demand imbalance. And with the demand side of the equation continuing to grow, it’s not surprising that RBC’s aggregate affordability measure worsened the most it has in 30 years last quarter, the fourth consecutive increase and a complete rollback of the affordability gains that were made during the pandemic. Affordability was a big issue in the federal election. And a wide range of policy measures were discussed to help make Canadian housing more affordable. Craig, which of these policies do you expect to see governments enact to deal with the affordability issue and which policies do you think will actually help affordability issues in the housing market?
Craig Wright: I think when you look at affordability, just definitional, that’s our calculation of the pre-tax income necessary service principle, interest taxes, and utilities. And, Nurit, as you suggested largest duration in 30 years, fourth consecutive duration on a quarterly basis. And all the gains we saw through COVID had been rolled back. But it was also broad based across all the major markets and all the major housing categories. And as we move forward, to your comments on the tightness in labor and the housing market, more pain is to come on affordability as prices affirm, rates interest rates will eventually rise. And some of the strong income gains we’ve seen in part reflecting the sizeable government programs will be rolled back as we go forward. So affordability challenge will continue over the near term. Governments have been looking at a number of ways. We saw the recent federal election, a lot of discussion about the housing sector by all parties. Unfortunately, most of the discussion there was to spur demand rather than support supply. And I don’t think we really need a whole bunch of support to spur the demand side.
Craig Wright: As I suggested earlier, most of the challenges for the Canadian housing market are on the supply side. And unfortunately for the federal government, I guess, is their tools tend to be more demand side management tools, most of the supply levers rest with the provinces and the municipalities. So the federal government probably should not be encouraging demand given how robust it is in a supply constrained world. Where they could kick in is perhaps to ease some of the challenges on the skills trade shortages, because they do have the hand on the immigration and that may help the sector on the supply side. But most of the challenge will translate into what the province and municipalities do and they need to continue to move, to increase supply. They need to speed up the approval process and hopefully also streamline the regulatory environment. So all that to say that the housing market continues to be tight, demands can take care of itself, very robust over near term, where we need the help is on the supply side so we can get more housing units to the markets.
Nurit Altman: The last, but certainly not least important piece of this puzzle is interest rates. With expectations that interest rates will begin to rise at some point in 2022, what do you see as the impact on the housing market? Will we begin to see cooling or worse, a collapse?
Craig Wright: It’s a great question. And everybody’s trying to get their head around the interest rate environment right now, given what’s going on with inflation. So our base case is that our growth scenario for Canada and in interest rate, our inflation outlook all suggest that from a Bank of Canada’s perspective, overnight rates we think will be 50 basis points higher by the end of 2022 relative to today. So overnight rates going from 25 basis points to 75 basis points. Market interest rates, mortgage rates, probably similar gains or maybe even slightly higher. So maybe 50 to 75 basis point rise. Significant rise from where we’re at, but in the grand scale of things, very modest interest rate environment, very low and stable as we move forward. Unless this view is premised on inflationary pressures we’re seeing today being transitory. So we’re in that team transitory camp, but most of the points are being scored right now by the persistence of these inflation pressures and a lot of them supply driven. With time, the supply like the housing market will catch up and ease some of those price pressures.
Craig Wright: We’re also dealing with some unfavorable base effects. So declines in many prices a year ago aren’t being repeated. So that’s pushing headline inflation measures up in Canada, US and around the globe. But they are longer lasting than what we’d hoped for and likely to continue over the latter part of this year. But as we move into 2022, some of these unfavorable base effects should fade, inflation expectations, usually in keeping in check in around that 2% target. So that’ll help cap any inflationary pressures. And the employment market, the employment’s up, but the unemployment rate’s still well above the five and a half or 6% level we thought was normal pre COVID. So that’s not usually environment where workers look for wage gains. They tend to focus more on job security. And the economy’s still operating below its capacity. So that’s not usual environment where inflationary pressures take hold and persist because business and consumer, the either inability to pass on price increases from a business perspective and a worker’s not looking for it.
Craig Wright: So if we’re correct, you get a 50 base point rise in interest rates. Affordability in that environment with all else unchanged, probably deteriorates another two percentage points. So very manageable, but we do have to keep in mind the sensitivity for small change in the interest rates is much higher given the debt buildup we’ve seen. So it is a small risk of a larger move in interest rates. But if we do get that small risk, it is going to be a significant hit to affordability and housing. So base case view, housing market cooling, not collapsing as we move forward.
Nurit Altman: Well, thank you Craig, for sharing your insights. One thing I can say for certain is that we will all be watching this market very closely. I’m Nurit Altman, and this is The Real Pulse.
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As Chief Economist, Craig leads a team of economists providing economic, fixed income and foreign exchange research to RBC clients. Craig is a regular contributor to a number of RBC publications and is a key player in delivering economic analysis to clients and the media through the Economics Department’s regular economic briefings.
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