Last month I outlined real estate froth at the local, national, and international levels. Two weeks later I discussed the specific local variables driving demand. Since then, new listings in Vancouver have doubled while total inventory remains flat - an extremely bullish signal.
This week, I explore national drivers contributing to housing froth which continues to show no signs of easing.
At the core of Canadian housing froth is quantitative easing. What is it?
Quantitative easing is when a central bank purchases government bonds, or other financial assets, in order to inject money into the economy and expand economic activity. Put simply, for Canada this has meant printing money to purchase mortgage-backed securities with the stated goal of promoting low interest rates and economic growth.
Canada is purchasing $4-5B of bonds, $500M being mortgage-backed securities, every week.
With a total of $400B of quantitative easing completed, Canada now owns 35% of the entire Canadian bond market. An obscene amount of liquidity for the mortgage market has been created, effectively suppressing rates.
Importantly, even if interest rates remain low until 2023, mortgage rates can increase if the Bank of Canada lowers its central bank market operations. However, any increase in yields will likely be met swiftly with more purchasing by the Bank of Canada, and potentially yield curve control - a policy measure dictating the price of money, not through free markets but through central planning.
The Bank of Canada cannot tolerate higher rates.
As publicly stated, rates will be maintained near zero through 2023, which will continue to stimulate home prices. The BoC is aware “inflation is born disproportionately by the less wealthy people who tend to operate more in cash, and so they tend to disproportionately bear the cost of inflation”.
However, in the BoC’s eyes, asset inflation is not inflation. Therefore, it does not expect its own target of 2% to be hit until at least 2023. A potential end to quantitative easing would result in higher long rates and correspondingly housing markets.
Another roadblock to 2% inflation is the continued strength of the Canadian dollar amongst international participants (we will discuss this further in another post). Commodity prices, specifically oil and grain’s bullish trajectory, continue to push the Canadian dollar’s strength.
With these barriers to its 2% inflation target, the BoC has maintained the policy rate at 0.25% despite terrible jobs reports (-200,000 in January, 5x worse than expectations), negative growth outlook, and higher Covid-19 rates. Commodities will likely continue to ramp and further push the BoC to maintain a low policy rate, if not lower it another 15 basis points in March or April. Importantly, if $CAD strength flips while rates are low, foreign speculation into real estate will increase - the only deterrent today is expensive Canadian currency.
Current rate policies have pushed Canadian residential investment to 9.43% of GDP, the highest rate seen in the last 60 years and even higher than the 6.7% seen during the US 2006 housing bubble.
Deferred mortgages disappeared.
The Canadian Bankers Association shows 743,000/93% of Canadian banks’ total deferred mortgages expired as of November 30th. The implication being roughly 45,000 mortgages are still left in deferral. If these homes were foreclosed or listed for sale, there still would have been fewer homes for sale across the country than in November 2019.
What does this mean? The deferral cliff was an absolute nothing burger. MICs and private lenders aren’t under stress, and most of them only allow for a one to two month deferral, unlike big banks allowing six months.
Home Sales and Immigration
Supply and demand is heavily imbalanced, driving price pressure upward.
A massive 550,000+ home sales occurred in 2020, more than the booming market Canadians saw in 2016 - when Canada attracted large amounts of offshore money and immigration.
Strength in single family housing is evident, with prices up 16% versus 4% in condos. Active listings remain below 100,000 for the first time in 30 years. Low supply, big demand.
Prior to Covid-19, Canada projected roughly 350,000 new immigrants in 2020. In reality, between January and August 2020 Canada only saw 128,400 immigrants. Completing the year with less than 200,000 immigrants for the first time since 1999.
Travel constraints and Canadian dollar strength are current barriers to foreign investment purchases, however it is clear that once these are resolved, demand will increase rapidly amongst what is already limited supply. The result? More froth.
A K-shaped recovery with exoduses from cities, perpetuated by $90B in cash.
Despite three million Canadians losing their jobs, those who maintained their occupations through the pandemic have seen massive net worth increases via inflated asset values.
The average homeowner’s newfound ability to simultaneously defer a current mortgage while purchasing an investment property has contributed significantly to housing froth.
Households have seen net worths increase $600B since the end of 2019, as homes surged nearly $440B in 2020. Canadians have an extra $90B in cash now. For those who were in a favourable position, investing in real estate was a no brainer.
Toronto rental vacancy is 3x higher than last year, yet prices are still going increasing [GTA up 10% year-over-year]. 50,000 residents have left the city for other parts of the province this year. On average, every 10km drive further from the city buys an extra $25,000 of house - Guelph seeing single-family home prices up 21% year-over-year; and Abbotsford 14% in detached homes.
Although quantitative easing has allowed Canada to avoid a severe economic crisis, it would be unsurprising to see Canadians push for more conservative policy makers as a K-shaped recovery is unraveling.
What Do We Do?
Until The Bank of Canada sees 2% inflation, it is on a mission to ensure rates stay low and the Canadian dollar weakens. This 2% critically does not include asset - real estate - inflation.
While the BoC continues to purchase mortgage-backed securities, lenders are in healthy positions to continue lending. Buyer demand has yet to peak due to the lack of immigration, and Canadian dollar strength; yet home supply remains constantly short of current demand.
Until circumstances change, the Canadian housing market has no reason to halt with its support from these drivers. While the Bank of Canada Deputy Governor Tim Lane may insist the cryptocurrency bull market is an artificial “speculative mania”, he ignores any concept of the same for Canadian housing. It is frothy and speculative, yet the froth is only in its beginning stages.