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Our real estate experts are back for another look at the state of Canada’s housing market. This time, they give us a snapshot of how rate increases have affected sales and listings, when we might see things pick back up, the impact the new rules around foreign buyers may have and much more.
Key moments this episode:
1:34 — What’s happened in the market since last fall
2:42 — A little context around interest rates
5:23 — How much volumes have dropped in the last year and why
6:50 — “Crystal ball time” – where rates may go from here
9:30 — How high qualifying rates have factored in
10:02 — How new rules around foreign buyers may impact the market
11:47 — What is the “stress test”?
13:46 — How is the housing supply keeping up with Canada’s ambitious immigration goals?
20:34 — How might the markets look in the next six months or a year?
Stephen Meurice: The last time we spoke about housing on the show was September. At that point, the housing market appeared to be hitting the brakes after what some might say was an unsustainable amount of growth during the pandemic. But even then, house prices were on average still higher than pre-pandemic levels. So, has anything changed since then?
Farah Omran: I'd say not much has changed since we last spoke.
SM: Okay, well that was easy. Thanks for listening, I guess that’s our episode. But of course, according to Scotiabank economist Farah Omran, that’s not the whole story.
FO: Yes, sales are still declining, but the sharp declines that we were seeing back in September at the beginning of the correction are getting progressively smaller.
SM: And, as always, Farah isn’t the only one here this episode to help us make sense of the housing market...
John Webster: What's taken place now is as rate increases have been absorbed, it’s completely changed the market.
SM: That’s John Webster, Scotiabank's Head of Real Estate Secured Lending.
JW: There are people who are in the industry who are still trying to adjust to the fact that it was feast, now famine.
SM: So, when will we see the market pick back up? What about the Bank of Canada’s potential interest rate hike next week, how could that factor in? How will the new rules around foreign buyers impact things? John and Farah have their crystal balls at the ready. I’m Stephen Meurice and this is Perspectives.
Farah. John, welcome back to the show.
FO: Thanks for having us.
JW: Good to be here.
SM: Let's maybe start with a bit of a catch up here. Farah, can you briefly sum up what has happened since the last time we spoke?
FO: Yes, the correction that we chatted about back in September is still happening. But the sharp declines that we were seeing back in September at the beginning of the correction are getting progressively smaller. And that's what we expected back in September. We expected the pace of the correction to moderate. Some of the factors that were driving the correction at the beginning have settled down. The prices have also been declining with the slowdown in demand but are still above their pre-pandemic levels. So, the MLS HPI index, we chatted about back in September, that is the more appropriate measure for prices relative to the average sale price, that is still around 35% above pre-pandemic levels.
SM: Okay, John, how about you? What's your take on where the markets are at? You're right in the thick of things. What are prices like compared to the last couple of years? But also, even looking back farther than that, I assume a house still costs more than it did, say, three or five years ago? I think that probably goes without saying. What's the situation from where you sit?
JW: Well, I think that in context, we look at what was taking place pre-pandemic and now we're looking at what's taking place post-pandemic. So, I think Farah’s observation sometimes needs to be reinforced with people. While there has been house price depreciation, we're still not at a point where we were pre-pandemic. But I think in the last several months, let's reflect. Since March, we've had multiple increases by the Bank of Canada. It started out 25 basis points and it's 4.25% today. And we another change potentially coming up in a week or so. And as a result of that, what was taking place during that time in the pandemic when mortgage credit growth was double digit in our case and housing activity was elevated and escalated right across all geographic sectors and all property types. What's taken place now is as rate increases have been absorbed, it’s completely changed the market. So, what you're seeing is that people had ultra-low interest rates and that encouraged them to buy, whether it be first-time buyers or step-up buyers. So, perhaps let's take the case of a variable rate customer during the pandemic and we're talking peak to trough, they might have been borrowing at 1% or 2% on variable. Well, today the variable is 6.45%. So, the reality is that’s a steep increase. Now in our case, as I've mentioned on previous broadcasts, our variable mortgage, the payments actually do increase as the rates increase, which is unlike our peers. And that's been a good thing in our case for our borrowers. But the reality is, think about it, you're making that payment on variable. And on average, I would guess that some of those folks would have payments that are $700 a month more than they were. So, there's been a lot of focus on variable rate borrowers. And of course today, variable rates are higher than the fixed. So, the two categories that are most popular from Canadians’ perspective are variable and five-year fixed terms. Now, the five-year fixed term is less expensive than the variable. So, the variable growth has stopped. But what most of the people in the industry and observers and stakeholders have been focusing on are who's vulnerable in the situation where house prices have depreciated, and rates have gone up? So, the price point where they bought during the pandemic was at the peak and now their carrying costs have continue to accelerate and will accelerate moving forward. For how long? You have to ask Farah. But certainly, for the next few months. And that has resulted in 40 to 50% less activity in the marketplace. So, we've seen volumes year-over-year drop by 40 to 50%. And at the same time, house price depreciation has been assisted because there has been so few listings. So why is that? If you're a homeowner and you're thinking about putting your house on the market, you're still trying to get your head around, ‘Why can't I get what was available at 2022?’ I've seen it in markets where I personally pay attention to and I see the listings and then they pull them back because their expectations haven't adjusted to this correction in house prices, which we think is healthy. So, on the demand side, looking out, we don't anticipate until rates start to come down, and whether that's what the back half of the year, to see more activity. There's also some seasonality, you know, at the year-end in December and January, those are historically the slowest months in terms of activity in the housing market and for the mortgage business. And so that's typical, but it's even more subdued than the pre-pandemic years in terms of volumes. So, the market has changed profoundly. There are people who are in the industry who are still trying to adjust to the fact that it was feast, now famine.
SM: Right. I will come back, as you suggested, to Farah just briefly to talk about that interest rate situation. John mentioned the increases, can you just take us through what's happened from an interest rate perspective over the past year? And as John said, we do want to hear what you think is going to happen going forward.
JW: Crystal ball time.
SM: Pull out the crystal ball.
FO: [laughs] Yeah, exactly. Well, the bank has done quite a lot over the last year. As John just mentioned, it's raised the policy rate by 400 basis points. It went from the effective lower bound of a 4% in March to 4.25% by December. So that's quite a hefty increase. But at the December meeting, the bank did signal a potential pause in its hikes as it assesses the impact of the previous hikes on growth and inflation. And this is in line with our forecast from early December, where we had the bank stay at 4.25% before starting to cut in late 2023, given the expected slowing in both inflation and growth. This is because data on the inflation front suggested that the expected slowing and inflation was happening and this increased our confidence that the bank was near its terminal rate. Now, since then, we did get an inflation print that showed core inflation accelerating in November, and we got a job print that crushed all forecasts and pointed towards persistent tightness in the labour market. So, both of these things pose an upward risk to our rate call and increase the chances that the bank will hike this month.
SM: Right. So always those weird mixed signals where a really good jobs report in some respects kind of feels like bad news.
FO: Absolutely. Since the pandemic, it's become where good news are just bad news. And we see the markets reacting that way to them as well.
JW: Yeah. I mean, in terms of the industry, though, there's on the demand side, you know, the anticipated hope of the Bank of Canada. Many critics felt that they lost the plot. It wasn't transitory inflation. They waited too long to make the increases. And then they've consistently raised the rates and hoped to dampen down. It's worked in the housing business because of the increased carrying cost and making it less affordable, less people are eligible, and as a result, that didn't dampen down headline inflation the way they wanted. Mostly because, as Farah said, there's still high levels of employment. But for our business that's a good thing because the most important variable in looking at a real estate correction or recession is that you have house prices coming down, but you have levels of unemployment going way up and that's what matters and we're not seeing that. So, it's sort of jobful inflation, but for us, what people forget and need to be reminded of, while rates have gone up and I mentioned both fixed and variable are many percentage points higher, we also qualified two points higher than the contract rate. So, if you came to me today, Stephen, I am underwriting you on your debt service at 8%, let's say, even if your rate is in the 6% level. And that knocks out a whole bunch of people that would like to get into the marketplace, whether they be first timers or new Canadians, because the carrying costs are too high. One of the things that's also happened, we've had, you know, restrictions on ownership, started January in this year. We've also put in some anti-speculative measures saying that you've got to be in your house for 12 months before you try to resell it. You've seen changes in B.C., where they've had a three-day cooling off. This year, starting in January, there's an absolute prohibition of foreign buyers for two years. If you're a foreign purchaser, you cannot purchase a home in Canada. And that's not dissimilar from some other jurisdictions like New Zealand and Australia that did similar things. But it's a little counterintuitive when you think that we're so dependent on immigration and inviting people here and then we're saying no, too many foreign buyers are using Canada to park money. The reality is it is very limited in terms of the numbers when it's been investigated. It's a hard thing to get a clear data point on, but now we've gotten to the point of taxing it. Same thing for vacant houses. Trying to look at whatever ways and means exist to make sure that the people bidding are mostly people that are resident in Canada is the way you look at it. All of those things have happened, and they aren't really dampening down the market because interest rates rising have done that. But it's qualifying rate that is set by OSFI that we have to underwrite you at was maintained, even with these high rates. So that's a double whammy on the demand side. But on the supply side, we talked about this in previous shows, we're going to be at record levels of immigration. And we're in a housing crisis in Canada and the affordability, not just in the urban centres, is the main symptom of that. So, we're in a strange place where input costs for builders have gone up. Building is slowing down, more people are coming, less people are listing. And so, it's making that side, the supply side, that much more challenging.
SM: I want to come back both to the supply and the demand side in a second. So, you talked about the qualifying rate. Is that what people refer to as the stress test?
JW: Stress test. Yeah. Same thing, interchangeable.
SM: They’re interchangeable expressions, so that means?
JW: It’s called the Bank of Canada qualifying rate and it's used as a stress test because they want to see that borrowers have that additional capacity. And I think that OSFI feels, and probably rightly so, that that was an effective cushion in terms of, if I was qualifying you at 2% during that period, we were underwriting you at 4%, but now you might be paying 6%. So, there is a cohort of borrowers that are vulnerable and we're tracking those very, very closely. The other side of the equation though, was household balance sheets were never in better shape. People had a lot more cash. So, we haven't witnessed the small percentage of people that purchased during the pandemic when prices were high, rates were absolutely low. They seem to be managing well. And the reason for that is we've had historical lows with regard to delinquencies going into that period and also much higher levels of cash-to-debt service. So, there is a group of people, but it's quite small in terms of the portfolio that are impacted. What I think in order for the recovery to turn around and see more activity in the housing market, we're going to have to see rates first stabilize and then decline.
Now what you've really seen in the last few months has been incredible increases in rental rates, and that's because of the fact that there isn't any more investment activity. So, the housing market, the demand and supply side, it's a very complex matrix and there's no one lever you can pull. And as a result, we actually in the short term are making the housing crisis going forward is going to become more difficult. So, if we thought it would take us ten years to get to a level, if we maintain this level of immigration, that we can build enough units and catch up, we're actually slipping backwards.
SM: So maybe we can talk about the supply part in a minute. But I just want to come back to Farah and talk to you about the demand side of it. And as John said, complex situation with many different factors, but clearly high levels of immigration are contributing significantly to that demand question. Canada this year, I think, was the largest number of newcomers that had been admitted to Canada, 425,000, something like that? And projected to carry on. Can you talk a little bit about what that policy around immigration looks like? What it's intended to do, but also some of the challenges and problems that it creates within the market for the people who are coming here and trying to rent or buy a home?
FO: Yes, I think talking about immigration and supply of housing come hand in hand. So, we're basically just not keeping up with our population's needs. It's no secret that our population growth is significantly above that of our peers. And as you just said, we had a record number of Canadian citizens in 2022 and the government announced even higher targets over the next few years. And it announced it with a commitment to increasing the share of economic immigration. So, what that means is that the higher immigration targets translate into more people arriving to Canada and translates into higher population growth and higher demand. So, in 2021, when we fulfilled quite a high immigration target, more than half of it was fulfilled by people who were already in Canada because of COVID and borders having been closed. But we see that share declining throughout last year, and with the commitment of the government to increasing that share, it's going to continue declining. And again, higher immigration targets will just translate to stronger demand for housing and that will put pressure on home prices within a limited space with limited supply of homes. And we see that in the data, where we see it very clearly is in rents. We see that as demand for housing slows down and sales activity slows down, more of the demand shifts towards the rental market. And that is putting a lot of pressure on rental prices. And as well, we see it and the ratio of completions to population change. That ratio has been trending downward since 2014 when we start seeing stronger inflows of immigration. But when the pandemic started, that ratio started trending upwards because it forced a stop to immigration and population growth, but already we see that it has turned a corner and is now trending downwards again. So, it's worsening again. This means that we're going to continue to see pressure on house prices of the underlying supply issue is not resolved. Now, the good news is that starts did perform significantly above long-term averages last year. The bad news is that starts seemed to follow the trend in sales. So, you know builders see high demand they respond by building more. When they see a slowdown in demand, they put off plans to build. So, naturally some slowing in starts activity is expected this year with the expected slowing in the economy. But with rising population and eventual acceleration of incomes, we know that demand for housing will resume. So, the hope is that starts will stay above historical average. But, it will be challenging because we need them to increase at a much faster pace than household formation in order to improve affordability.
JW: But it's more expensive for them to build. The input costs have gone up, so those things all contribute.
JW: But we have to also remember in terms of those immigration patterns, it's disproportionate the numbers that end up coming to the larger urban environments. So Toronto, Vancouver, Montreal, for example, they take the greater share of that. And so those are the ones that have the greatest need for more supply. So that puts pressure on, ‘How are we going to find enough units to house all these people we've invited to the country?’ You look at it historically, going back, say, ten years, we would roughly set immigration targets that were around 1% of the population. So, people would say, ‘Oh, you know, it's not that dramatic that we're up to 500,000.’ But in terms of absolute units, it's a challenge. So, people would argue with me saying, ‘Well, we always want in about 1%.’ Well, it was different when it was 20 million and 30 million than it is today. And we need those people. We need their skill sets. We need them to come to build out this large land mass where we don't have enough scale. And we're challenged by that right now. But it is an important driver of household formation. It's the most important. The other thing you got to remember, for first timers, there's a cap on the borrowing. So, if you're a first-time borrower, want to take advantage of those very high performing programs for first time buyers, you're limited at $1,000,000. And there's just not a lot of product in Vancouver and Toronto. So, in other markets it's still attractive, but there's virtually very, very little activity taking place there. In the condo market there still is. But Farah’s absolutely right. As soon as rates started to rise and the new psychology said, ‘Oh, prices are coming down, we should wait, interest rates are rising.’ Condo sales fell off. For new people coming in, they're looking at longer delays and higher input costs. So, the square foot costs of condo have continued to accelerate all throughout this period in the major urban markets.
SM: Right. Just to come back to the immigration issue for one second it's maybe worth talking about, Farah, a little bit why Canada has this high level of immigration. Maybe just because we've been talking about it, about the impact, arguably negative if you're looking for a house of a huge number of new people coming to the country. But Canada needs new people, right?
FO: Yes. Well, so the motivation for the federal government to be announcing these higher targets is the fact that we're seeing historical tightness in the labour market. A shortage of labour is pushing wages upwards, which is pushing inflation upwards, which is also we're seeing more shortage of labour in construction industries compared to other industries, which is holding back housing supply. So, it's really at the core of the problem and they're using this as a lever to solve this problem. Now, when the government sets these immigration targets, at the end of the day, it is the government's responsibility to make sure that it's meeting the needs of these newcomers. These newcomers are going to need homes to live in. And it's the government's responsibility to make sure that the immigration target makes sense with their housing availability, or that it makes sure that it builds enough housing for the immigration target, among many other services that they need to ensure that they are able to provide these newcomers.
SM: Right. I'll ask you each roughly the same final question to put on your prognostication hat. Farah, from an economic perspective, given all those circumstances that you talked about, what are you looking at in the next six months to a year?
FO: You know, I will say if the past few years have proved anything is that it's very hard to see or guess where things are going. But it seems that we can't quit trying and we do see more room for prices to continue to decline this year, especially as the higher prices of housing and other goods and services combined with higher policy rates, weigh on demand and sentiment. And the market psychology has shifted and people now expect prices to decline, so they might stay on the sidelines because the more they decline today, the more they expect them to decline. And when they stay on the sidelines, that would put more pressure down on prices. So, it's a bit of a self-fulfilling prophecy in that sense. So, prices are continuing to decline in 2023, given how much higher than pre-pandemic levels they still are, but by how much and for how long varies significantly across cities and population dynamics as we’ve been discussing, will play a big role in determining that. So, so far we have seen bigger adjustments down from peaks and cities where prices rose more since the pandemic started. But on the other hand, we see some cities where prices have barely fallen over the last year. For example, Calgary is seeing prices rising still and they're now above where they were in February of 2022 when the bank started hiking. Now, Alberta did see a record-breaking increase in its population last year, reflecting in part cheaper cost of living. And that is expected to continue, which points towards more pressure on housing prices in cities there. We did see, for example, the share of new immigrants settling in Atlantic Canada, also accelerating and we are expecting that to continue to be the case. So again, points to more pressure in that region. And that's likely why in a city like Moncton, where prices did go up by a lot since the pandemic started, prices there have barely fallen over the past year. So, I would say that population dynamics are going to play a very important role in determining housing market outcomes over the next year.
SM: John, how about you – final thoughts as we look ahead?
JW: Yeah, it only makes sense to most people that the markets where they went up the most would be the first to decline the most. Because in all property types, recreational, other market areas, there was a lot of the psychology that was working towards it and it fueled itself. Now it's sort of been in a correction and come back to Earth. A lot of the bank economists, some of whom are quoted a lot in the media, have said, you know, ‘This isn't a crash, it's a correction.’ But for our listeners, what they should do because Farah’s department with herself and JF on their housing outlook, they've been pretty accurate in predicting where we're going to go. And so, if you want to get that background, what I do whenever I'm trying to figure out where are we going to land, I look at that, I look at those numbers and say, ‘What should I anticipate for mortgage credit demand going forward?’ Because it's so dependent on all the factors that we've discussed. But for consumers, it's tough. It's tough to qualify because of the qualifying rate. It's tough because they got used to over several years to very low payments and now those payments are much higher than many of them have ever experienced before. But I think that people believe that that will stabilize and come down. When rates come down you're going to see, in my view, and I'm not an economist, but I believe that the pickup will be much faster than people anticipate because there's a lot of demand out there. People that I talked to that are waiting on the sidelines, they know, ‘Will prices come down further? Oh, it's a little too expensive.’ But then they go out and see that a one bedroom in Oakville, they're charging $3,500 a month to rent and they're going, ‘No, this doesn't make sense. I'd rather be building equity in my home.’ And at the end of the day, from my perspective, and it's not self-serving because I'm responsible for the mortgage business, I think for the average Canadian, the best investment they can make is buying a home. And you have to remember, you're living in it. It's not just an investment, it's where you're going to live and you know, spend the holidays bingeing on Netflix.
SM: [laughs] All right. Well, on that jovial note, I think perhaps we'll leave it there. Thank you, John. Thank you, Farah. It's always great to have you here. Really appreciate you coming.
FO: Thanks for having us, always fun.
JW: Thank you.
SM: I’ve been speaking with Scotiabank economist Farah Omran and John Webster, Scotiabank's Head of Real Estate Secured Lending. The Perspectives podcast is made by me, Stephen Meurice, Armina Ligaya and our producer Andrew Norton. Who knows the only thing worth bingeing at home over the holidays is the Perspectives podcast.