Aimeric Atsin
The global economy has been hit hard by the COVID-19 pandemic and continues to be affected; no country has been spared. We are experiencing a boom-and-bust economic recovery after a third wave and the specter of a fourth wave, which raises more doubts about our economy's resilience. Considering that the residential real estate market is one of the most important contributors to GDP growth, It is essential to examine its health. Assessing how the Canadian dream of homeownership was affected through this challenging period can provide helpful context for understanding the impacts on this industry and help guide new policies to calm the market. In this note, we selected a number of metrics for both supply and demand in the housing market.
In the radar chart below, housing demand metrics (Right), supply metrics (Left) are scaled relative to their level in February 2020(100). That means that the metrics can be viewed as percentage gains or losses relative to that point. So, for example, a metric with a value of 135 in March 2021 has improved by 35 % relative to its value in February 2020. Conversely, a value of 80 in March 2021 is a sign of deterioration by 20%.
Housing demand has been strong
According to the Bank of Canada (BoC), the housing affordability index (it measures the share of disposable income spent on housing costs) declined by 15.3% in the second quarter of 2020[1], reflecting less restrictive conditions for homeownership. Since then, it has gradually risen to exceed its pre-pandemic level in 2021Q2. The consumer house-buying power increased at the outset of the pandemic because of lower mortgage rates and higher Household Disposable Income (HDI). In March 2021, the conventional mortgage rate 5-year and the Estimated Mortgage Variables Rate (EMVR) were lower than their pre-pandemic values – the 5-year conventional mortgage rate was 3.26 %, 0.82 % lower than in February 2020. The EMVR was 1.49 % in March compared to 2.89 % the month before the lockdown. In 2020, the HDI edged up 13% in the second quarter relative to the first quarter, thanks to additional transfers from the government to help the households cope with the lockdown. Since then, there has been only a slight decline HDI relative to its peak in 2020Q2.
Mortgage rates continued to stay low and stable through August 2021. This, together with rising disposable income, indicates favorable conditions for housing demand.
At the same time, the number of potential home buyers may have increased despite the pandemic. The changes in HDI and the mortgage rates positively influence the consumer house-buying power. Greater consumer house-buying power has offset the increase in home prices. This is reflected in a rise in the value of mortgage loans by 11% from February 2020 to June 2021.
In June 2021, the residential average sales price was 25% and 36% higher than their levels in February and April 2020; it does not tell the whole story on affordability in Canada. This indicator can be misleading because of the influence of the expensive markets of Toronto and Vancouver.
According to the Canadian Real Estate Association (CREA), the Home Price Index (HPI) is a more accurate indicator of housing prices. It is based on the value home buyers assign to various housing attributes, which tend to evolve gradually. It, therefore, provides an "apples to apples" comparison of home prices across the entire country. The Home Price Index (HPI) was 26 % above its February and April 2020 values. So, the uptrends continue to be felt on the different prices and don't seem to stop soon.
It is important to note that prices for new houses have not shown as much vigour recently. Statistics Canada's New Housing Price Index (NHPI) is 12% higher than the worst month of the pandemic. But unfortunately, it gives us only a picture of a market segment.
Since the pandemic outbreak, the BoC has played its role as a market regulator to keep rates from soaring. This intervention helped maintain access to credit for Canadians. Indeed, the massive asset purchases reduced the rates on five-year fixed-rate mortgages by similarly impacting the yield on five-year government bonds. All of this has made it more affordable to borrow to buy a house.
According to some experts, this stimulus in the mortgage market could help create two critical vulnerabilities or potential problems. First, the sharp increase in housing prices may bring forward demand for housing as potential buyers may fear further rise in prices. This would likely reduce demand for housing and housing prices in the future. Secondly, the market's reaction to the withdrawal of stimulus or "Taper Tantrum" may be a potential problem. Indeed, the return to "normal" mortgage rates can lead to a temporary market contraction as a higher cost of borrowing would reduce the demand for housing.
Supply Struggled to Keep Pace with Demand
On the supply side, the sales-to-new listings ratio (the number of sales divided by the number of new listings) is a good indicator of supply conditions in the housing market. As reported by Liv Real Estate, this is a gauge: "of whether we are in a buyer's market or a seller's market. There is no standard ratio, but some analysts agree a ratio less than 40% is a buyer's market, 40%-60% is a balanced market, and over 60% is a seller's market". The indicator over the past two years (Since July 2019), shows that we have had a seller's market in Canada, except in May 2020, where it fell slightly in the "balanced" range. June 2021's sales-to-new listings ratio was 70.3%. This seller's market may be one reason why, despite the pandemic, housing prices continue to rise in Canada.
In the same vein, another effective way of measuring supply conditions is to examine the rate at which homes are selling or the Months of Residential Inventory (MRI). As reported by the Canadian Real Estate Association (CREA), the MRI indicates "how long it would take to completely liquidate current inventories at the current rate of sales activity." According to this measure, a seller's market occurs when the MRI is at or below four months; in a balanced market, it is between four and six months; a buyer's market is when the MRI is more than six months. The MRI declined significantly from April 2020 to February 2021, after a substantial increase between February and April 2020. In April 2020, the monthly residential inventory surged significantly to 9.1 from 3.9 in February. It dropped to reach 1.8 in March 2021 and rose slightly to 2.2 by August, indicating that we are currently in a seller's market. If no other residential houses came on the market, the current supply would run out in 2.2 months, well below the normal inventory. This means the buyers have to make bolder offers with shorter closing dates, few or no conditions, and even cash deals.
The housing starts, a leading indicator of new home completions, were 22% lower in April 2020 than during the pre-lockdown month. They recovered to reach 333,284 in March 2021 before falling back to 270,744 in July of this year. However, since then, they initiated the recovery to get a record (333,284 units) in March 2021, and they were 58 % above their February 2020 level. Subsequently, housing starts slowed down to 270 744 in July.
The number of dwelling units completed also followed the same path. The completion rate declined at the start of the pandemic and then recovered sharply. In June 2021, it was 20% above February 2020
After declining at the start of the pandemic, residential units sales increased to a record level of 67,583 in March 2021, then slowed down to 48,379 units in August.
The unabsorbed inventory had declined each month since February 2020, when it stood at 7,449 homes. By the end of July, that number was 6,393 and 5,983 at the end of September. In March 2021, inventory was 4,340, comprised of 3,219 single-family homes, 1,121 semi-detached. So, the unabsorbed stock was 42% below the February 2020 level despite the pandemic. In June 2021, it was 51% below the February 2020 value at 3,686, comprising 2,817 single-family homes and 869 semi-detached.
Another important indicator is the Number of Residential Building Permits (NRBP) issued by the municipalities in Canada. Despite the total lockdown in April, the NRBP was 22% higher than in February 2020. Moreover, this number continued to increase significantly until July 2020 where it was 184% above the February level. Subsequently, the difference fell to 120% in March 2021 and traced back to 188% in June. Nevertheless, it was still well above the values observed last year.
Demand Steadily Grew, But Supply's Paucity Still Prevailed
The residential real estate market indicators presented above paint a relatively straightforward portrait of the Canadian situation. Over the past year, prices have seen sustained increases contrary to the expectation that the pandemic would reduce housing market activity. Under the pressure of increased demand, the inventory has been reduced substantially. This is also attributable to a supply shortage, despite the uptrends observed for several supply indicators.
The Canadian housing market has been quite active during the pandemic. It was the main driver for Canadian economic growth in the first quarter of 2021. Fiscal stimulus and mortgage deferrals, along with low-interest rates and pre-covid solid demographic fundamentals, are the main reasons for this. But the slowdown in migratory flows to Canada observed over the past year, due to the pandemic, will negatively impact demand in the short and medium-term. In fact, in the third quarter of 2020, net international migration was negative (-27,143 people), a first since the fourth quarter of 2014.
Furthermore, according to the BoC, interest rates could increase earlier than expected. Even though the pandemic has boosted demand over the past year, a slowdown is possible in the near term. Higher mortgage rates, together with a rebound in supply, could ease pressure on housing prices.
On the other hand, Canada's immigration policy is expected to be very aggressive for the next few years. The annual targets have been revised up. This will significantly affect the housing demand, which can maintain the upward trend in prices if adequate investments are not made to boost supply.
This pandemic has highlighted more the inadequacies of the supply in the Canadian housing market. With the pandemic, demand is more robust, but several years of building deficits have helped accentuate the supply shortage in Canada. But as Sam Kharter, chief economist at Freddie Mac, pointed out, referring to the US market, which also faces the same realities: "This is what you get when you underbuild for ten years."