OPP. Today – No housing market bubble in Canada, says report

By Adrian Bishop, OPP.Today

Canadian property prices are likely to rise 5.3% on average in 2017, twice the consensus of other estimates – but there is no market bubble, says a leading developer.

A significant share of housing demand in Canada is coming from the approximately 300,000 new immigrants that arrived in 2016, according to The Fortress RDI forecast for Spring 2017, the Market Manuscript,  which is a bi-annual report on the Canadian housing market

There has never been so much focus on residential housing markets in Canada as there is today, especially as Toronto and Vancouver have been named among the hottest housing markets in the world, says the report.

“For years, people have falsely claimed that the Canadian housing market is in a bubble, but now that residential house prices are accelerating faster than any country in the world, it is worthwhile to examine the subject again.

“The biggest problem stems from the fact that most people don’t have the foggiest idea what a housing 2300bubble is, how you would identify it, and why it is something a country or metro area should avoid.

“There are numerous definitions of what bubbles are, but here is a good one from the Institute for Fiscal Studies (IFS) out of the United Kingdom: “The idea of a ‘bubble’ is that asset prices are driven by expectations of future price increases rather than by the intrinsic value of the asset involved.” IFS identifies three key elements of a bubble: speculative buying for capital gain, speculative lending to non-credit-worthy clients, and a trajectory of explosive price increases (typically followed by an equally spectacular collapse). The federal government in Canada is currently considering these elements, especially the second one, despite claims to the contrary, says the report, but there is little evidence of rapid speculation in the Canadian housing market.

Housing demand is supported by record immigration in Canada. Ottawa recently confirmed that their immigration target for 2017 at 300,000. Immigration has trended upward since the late 1990s when annual immigration dropped to approximately 175,000.

Senior Vice-President of Market Research and Analytics, Ben Myers, says, “With the high price growth in 2016, there is much debate regarding the market dynamics that are pushing up values and whether the housing market is a bubble waiting to burst.

“This report differentiates fact from fiction and anticipates where the housing market is headed in 2017, especially in the red hot Toronto market.”

“The 15% foreign buyers tax implemented in B.C. in August clearly impacted the market, with transactions plummeting and average prices dipping. However, part of the decline in average prices and the number of homes traded is the result of domestic buyers’ and sellers’ expectations of a huge drop in values as a result of the tax.

“Don’t misconstrue the impact of the tax with buyers’ and sellers’ opinions of the future impact of the tax! The biggest impact has been felt on single-detached housing in Vancouver, with 18 of the 22 sub-areas within the Real Estate Board of Greater Vancouver  declining over the last three months of 2016 (only three of those areas have average prices under $800,000). However, just eight of the 22 sub-areas have experienced a decline since October for apartments. So, in reality, the tax made houses slightly less expensive for rich people and did very little for affordability in the marketplace.

CIBC’s Ben Tal says that when the fog clears, the foreign buyers tax will have less impact than people think it will. It will be worthwhile revisiting prices in Vancouver in six months—that will be a much better test of its impact once the “shock and awe” of the surprise tax wears off.

People clearly think a tax will work in Toronto as well, a poll conducted by Mainstreet Research in the fall of 2016 found that 52% of Torontonians favoured a tax on foreign buyers; only 21% opposed it, says the report.

“Despite CMHC’s 2016 survey showing a noticeable decline in foreign ownership of existing condominium apartments in Vancouver, Toronto, and Montreal in comparison to 2015, Canadians will continue to blame foreign buyers as long as the media keeps the topic at the forefront of their coverage of the market. The election of Donald Trump, and the continued coverage of Brexit and global protectionism, will prevent the topic from fading away in 2017.”

Eighty-four percent of online respondents to the Fortress social media survey expect Canadian resale house prices to increase in 2017.

Domestic and international analysts have compiled a list of the root causes of house price inflation, including the increase in high-paying jobs in Canada, and the tendency of these jobs to concentrate in cities.

Canadian residential builders and developers cite the lack of new supply as primary driver of resale house price inflation. Low borrowing costs and high immigration were also frequently named.

Assessing when house prices are out of line with economic fundamentals is as much art as science but the foreign buyer tax imposed in Vancouver is not the solution, the report suggests. “Lost in the foreign buyers tax debate is this conundrum: If Vancouverites and Torontonians have such a problem with offshore purchasers, why are so many of them willing to sell their houses to them?”

The typical measures to identify a housing bubble, like price-to-income, are insufficient. Between 2000 and 2015, house prices went up faster than wages in Australia, Sweden, UK, France, Korea, Finland, and Spain, the report points out.

High-ratio mortgages in Canada are decreasing while first-time homebuyers increase down payments. Only 9% of Canadians that purchased a home between 2014-2016 have less than 10% equity in their home.

International evidence suggests bans on foreign buyers won’t stabilize house prices. CMHC’s Evan Siddall believes foreign investment clearly is a factor in house price gains, but restrictions don’t always ease prices.

Elasticity of supply is the most important concept in housing right now. If supply is ‘inelastic’ (unresponsive), higher demand will translate into higher prices rather than more residential construction.

The probability of a housing market crash in Canada is low. Housing market disasters among OECD countries occur with a probability of 3% every year per the Bank of Canada economic analysis department.

Low interest rates are set to remain for some time. “A very substantial resurgence of economic growth, income growth, and/or inflation would have to occur (and the rise would have to be sustainable), before we’ll see any rapid rise in interest rates in Canada.”

The number of new housing units launched last year fell 10% annually to 35,611 units, while new home sales jumped 12% to 47,161 units, a nearly 12,000-unit gap.

The consensus forecast for 2017 is calling for about 39,000 housing starts, a nearly identical year as 2016, but above the 10-year average of 36,229.

Back of the envelope calculations reveals that the Toronto CMA is building about 30% less square footage than it did 15 years ago, despite a similar level of total unit completions.

The 52% decline in GTA unsold ground-oriented new home supply contributed to the 19.9% year-over-year price increase in that market segment.

The Urbanation unsold index price for new condominiums climbed to $645 per square foot in the Greater Toronto Area (GTA) in 2016, an increase of 7%. Resale condo price growth topped 15% annually last year per the MLS HPI.

Nearly 60% of developers believe urban containment policies like the Greenbelt, the Places to Grow Act, or the Agricultural Land Reserve are responsible for high new home prices.

Low municipal approvals are contributing to higher new home prices with 30% of developers indicating it will take them five or more years to get approvals on their suburban single-family housing developments, while 5% of developers anticipate 10 years or more.

Developers are not holding land with more than 80% wanting to develop their properties as soon as possible and 17% of developers that own approved lands choosing to be strategic about when they launch their sales programs per survey.

There is a fundamental disconnect between experts in the real estate market about the idiosyncrasies of each other’s areas of expertise, and their opinion on how they impact housing market valuations, says the report.

Economists are the most trusted source of housing market opinion and analysis according to the Fortress social media survey (54%), followed by developers at 15%, and urban planners at 10%.

The Halo Effect, where urban housing demand pressures spill over into  areas surrounding Toronto, has resulted in double-digit price gains in Hamilton, Brantford, Cambridge, the Niagara Region, Guelph and Barrie.

When construction completes on new units and they are occupied, there are ripples throughout the housing market as new occupants leave another dwelling. This frees up a unit for someone else.

In future, about 35% of Canadian developers are looking at developing singles and townhouses outside their metro area, with 31% looking at suburban condominium projects per the Fortress developer survey.

Fortress Real Developments Inc. is a Canadian real estate development company that seeks out and analyzes real estate development opportunities in major Canadian markets. The company is focused on quality projects  in residential low-rise, high-rise, and commercial market segments.