Canadian Real-Estate-Bubble Chart
Book - July 2012
Note:
A December 2012 update of this report is now available (click here)
The
following report is our latest
update of trends and valuations of the Canadian real estate
market. The
34 charts and two tables included below comprise an exhaustive
look at
the valuation drivers of Canadian real estate. This summary
has been
generated solely for educational purposes and we would like to
thank Teranet and National Bank, Statistics Canada, Standard
&
Poors, UBC Sauder School of Business - Center for Urban Economics and
Real
Estate, and Google
for making numerous data elements and housing price indices available
for generating the following summaries. For definitions of
the data
used in this summary please visit the following sites:
UBC
Center for Urban
Economics and Real Estate.
Teranet - National Bank Home
Price Index TM.
Statistics Canada for access
to their CANSIM database
S&P Case-Shiller Home
Price Indices
Google
Trends
We
welcome feedback, email realestate@pacificapartners.com
or tweet: @pacifica_prtnrs
Summary
For
the past three years the Canadian
Finance Minister, Jim
Flaherty, and the Governor of the Bank of Canada, Mark Carney, have
preached caution to Canadian households on the risks
of excessive debt accumulation. Neither have gone so
far as
to declare an asset valuation "bubble" within the Canadian real estate
market. However, both Minister Flaherty and Governor Carney
have both addressed
the issue publicly on a relatively frequent basis.
Included below is a small sampling of their
publicly
made warnings from December 2010 to June 2012. Included in
these
statements is
a recent one from June 21st in which Governor Carney addressed
excessive
mortgage related lending
as "the number one... domestic risk to the Canadian economy":
“Our
parents were more inclined to pay off that mortgage as soon as
possible, and some Canadians are not as inclined to do that now...I
encourage them to do it.””
“... we want to caution Canadians [that] we will not
facilitate excessive
debt assumption by some Canadians at very low interest rates because
that will lead to trouble in the medium and longer term.”
- Jim
Flaherty, Jan
17, 2011; lfpress
"The
risk is that expectations become extrapolative, prompting the classic
market emotions of fear and greed - greed among speculators and
investors, and fear among households that getting a foot on the
property ladder is a now-or-never proposition,"
"Canadians,
particularly with respect to residential mortgages, should be mindful
that interest rates are historically low right now. They're
not going
to stay there forever,"
- Jim
Flaherty, Nov
25, 2011; Reuters
“We
have been cautioning Canadians for some time that they need to be
prepared to have higher interest rates in the future and be aware of
the affordability issue that may create.”
"These
measures [tightening government-insured mortgage lending standards]
reduce the number one
risk,
domestic risk to the Canadian economy,"
- Mark Carney, Jun 21,
2012; Reuters
Fortunately
for indebted Canadian households, interest rates have yet to
return to pre-recession levels as was hypothesized by many.
In fact, the exact opposite has occurred with lending rates
dropping as global economic events, dominated by the European Debt
Crisis, unfold. These events have been partly responsible for
the
Bank of Canada's (BOC's) decision to pause on interest rate
hikes. Adding to the BOC's policy decision
has been the effects on interest rates from investors shifting
capital from equity markets and into bonds.
How
does all of this activity impact lending rates?
The increased demand for
bonds that we have witnessed has
caused bond
prices to surge higher. When bond prices rise in value the
result
is
falling bond yields, the key driver
of lending rates, and in particular rates on fixed rate
mortgages. To
understand the magnitude of falling Government bond yields, inflation
adjusted bond yields on many government bonds are now below
zero.
In other words, income payments on some government bonds are now
insufficient to overcome the loss in purchasing power that results from
inflation. Simply put, when it comes to borrowing "
money is
cheap".
From equities into bonds: The
catalyst for the exodus from equity markets into bonds has been
twofold. Firstly,
investors fearing continued volatility of global equity markets have
sent them fleeing to the safety of the bond market. Secondly,
signs of
inflation that were brought about by the US Federal Reserve's
Quantitative Easing program have dissipated. In turn, the
world is
now facing the sobering possibility that we are
headed into a
deflationary environment in which long bonds are expected to outperform
other assets.
Household Debt stalling: A
noteworthy observation is that despite falling
bond yields and the resulting mortgage wars between
Canadian lenders, debt accumulation by Canadian consumers has not grown
significantly. Canadian household debt, both mortgage and
personal debt, have
stalled at the 90% of Gross Domestic Product (GDP) mark for a number of
quarters (see
Chart 2
below). Furthermore, growth in Canadian personal
debt (excluding mortgages) has also
fallen, and is now growing at the lowest rate in more than a decade
(see
Chart 1
below). If this trend continues, Canadian consumer
credit may begin contracting. This contraction would be
despite
the fact that as mentioned earlier, borrowing rates
have fallen and borrowed money is now "cheap".
This observed slow-down of debt
accumulation has occurred even before a significant change to mortgage
lending rules took effect on July 9th, 2012. The rule change
will
likely act to further slow the accumulation of mortgage debt as
well. As a
result, we believe
that the
Canadian consumer has hit a point of "
debt exhaustion" in
which debt
accumulation stalls not necessarily due to restrictive credit or higher
borrowing
costs, but due to the accumulation of multiple factors including
economic fears, sentiment, stubbornly high unemployment, stagnant wage
growth, as well as debt servicing limitations.
Why
is debt so important to Canadian Real Estate? As
the charts below
demonstrate, the decade long bull market in Canadian Real Estate has
not been the result of "healthy drivers" such as income
growth, growth of the economy,
nor is it the result of housing scarcity. In fact,
housing
price growth has outpaced wage growth (see
Chart
6 below) and GDP growth
(see
Chart 5
below). In addition, most major Canadian cities are
significantly over-supplied
(see
Chart 3
below).
Instead,
housing price appreciation has been made
possible in large
part due to rampant debt accumulation, both mortgage and personal
credit (see
Chart
5
below). Thus a lack of future debt accumulation by households
implies that the key driver of past real estate performance may no
longer be available to stimulate real estate going forward.
Shifting
sentiment:
As
with all bull markets, changes in sentiment are a key indication of
whether an inflection point has been reached. Our
Real Estate Sentiment Indicator (see
Table
1
below) shows that
the
six cities with the highest search volume
proportions for
the combined terms of "Housing Bubble" and "Real Estate Bubble" are now
all Canadian. We interpret this as a noteworthy
sentiment shift
within these real estate markets. Effectively, the locals of
each
of the indicated cities are
now searching for bearish real estate terms in proportionally
more
volume
than other topics when compared to other cities around the
world. The increase in use of these search terms indicates a
potential change in consumer sentiment which may then extend to a pause
in real estate's upward price momentum.
How
overvalued are Canadian Real Estate markets?
We have attempted to quantify the
necessary price drops to bring specific real estate back to historical
average multiples of discounted rental income. The findings
of
Table 2 below indicate a
required 30% to 40% correction in home
prices in some major Canadian markets to achieve a return to long run
averages.
Our
outlook on Canadian real-estate remains negative.
An
update to this Chartbook will be published in November 2012.
Chart
summaries are provided below and are divided into the following
six categories:
Section A
(table 1 & 2 charts 1 to
4):
Canadian
Real Estate Sentiment, Canadian Consumer Credit
Growth
- NEW,
Household Debt as a Percentage of GDP, Real Estate Supply &
Demand
- NEW,
Canadian Real Estate Valuation and Correction Table
- NEW
Section
B (charts 5 through 10):
Canadian Real Estate Market Trends, Valuations, and Drivers of Home
Prices
Section
C (charts 11 through 18):
Canadian Real Estate Unemployment, Vacancy Rates, and Home Price Growth
in Major Canadian Cities
Section
D (charts 19 through 22):
Canadian and US Real Estate versus Stock Markets (TSX and S&P
500)
Section
E (charts 23 through 26):
US Housing Price Performance vs. Major Canadian Cities
Section
F (charts 27 through 33):
Home Price and Sales Pair Volume Change for Major Canadian Cities
Section A (Tablea 1 & 2 and Charts 1 to 4):
Canadian Real Estate Sentiment, Wage Growth, and Housing Supply
Table 1)
Housing Bubble Sentiment
Indicator
Canadian
Real Estate bulls have continued to cite the fact that real estate
valuations have appeared "expensive" for years, yet, the momentum
has continued to take prices higher. Real estate bears, on
the other
hand, claim that home prices have been so stretched from fundamental
valuations that past price momentum is irrelevant. As with
all asset classes, a change to investor sentiment regardless
of the
catalyst that triggers the change (eg. rising interest rates,
government policy, extreme valuations, etc.) will dictate future real
estate returns.
To attempt to monitor real estate sentiment analytically, we examine
the proportion of
Google searches for the combined terms "housing
bubble" and "real
estate bubble", summarized by the originating city of the
searches. The table below displays the top ten cities
globally in which the term "housing bubble" or "real estate bubble"
was searched in each year
from 2004 to 2012. The
six highest proportion of city-sourced searches for
"housing bubble" and "real estate bubble" arise from Canadian cities,
namely Vancouver, Ottawa,
Toronto, Calgary, Edmonton, and Montreal. The
progression of the
trend is ominous
as California cities dominated much of the top searches until 2009,
after which Canadian and Australian cities began to emerge.
Click Here to view a larger version of
this table.
Chart 1)
Canadian Consumer Credit Growth Rates - NEW
Despite
falling interest rates,
Canadian consumer credit growth has slowed to the lowest levels in more
than 12 years. This observation is despite the fact that real
bond yields, or inflation adjusted yields, have dropped
significantly. The axis on the right in red tracks 3
to 5
year real
Canadian government bond yields which are now below zero. In
other words, interest income on these bonds are no longer sufficient to
overcome lost purchasing power from the effects of inflation.
Should consumer and mortgage credit begin to contract then this
will serve as a major headwind to future real estate appreciation.
Click Here to view a larger version of
this chart.
Chart 2)
Canadian household credit
as a percentage of nominal GDP
Canadian
household credit, both consumer credit and residential
mortgage credit, has increased sharply over the last decade.
Total
credit as a percentage of nominal GDP increased from under 60% during
the third quarter of 2001, to the current levels
of 90%. The
surge in Canadian
household debt is predominantly comprised of residential mortgage
credit as can be observed from the chart below. Canadian
consumer debt
accumulation appears to have been exhausted and is currently in a stall
state of approximately 90% of GDP. Lack of debt accumulation
is a headwind for further real estate price appreciation.
Click Here to view a larger version of
this chart.
Chart 3)
Real Estate Supply and
Demand Growth: Vancouver,
Calgary, Edmonton, Winnipeg, Ottawa, Toronto,
Montreal, Halifax - NEW
In
all major Canadian housing markets housing capacity
growth has exceeded population increases between 2001 and May
2012. Calgary, Edmonton, Ottawa, Montreal and Halifax are
what we
would
consider to be "severely overbuilt" with excess housing capacity
of 50% or more than population growth over the same
period.
Vancouver, Toronto, and Winnipeg, are "overbuilt" with excess
housing capacity 20% more than population growth over the examined
period.
Housing capacity is defined
as the number of individuals that can be reasonably housed in new
housing units, whether or not a new housing unit sits unoccupied,
under-occupied, or over-occupied. Assumptions made may be
more appropriate for some markets over others.
Click Here to view a larger version of
this chart.
Chart 4)
Canadian home prices over
discounted rent valuation: Vancouver,
Calgary, Edmonton, Toronto, and
Montreal
In
theory, residential real estate prices should equal the discounted
sum of future rental income. As a result, we have attempted
to estimate
fair values for residential real estate in major cities by comparing
actual prices to theoretical discounted prices (valuation
ratio). In theory, this ratio
should equal one and deviations from this value should regress back to
the value one over time. Note, discounted cash flow
calculations are highly volatile
and dependent on underlying model assumptions.
However based
off of this
methodology, Canadian real estate appears extremely expensive in most
major markets. Canadian real
estate only appears somewhat reasonably priced if the assumption that
current
emergency low interest rates continue indefinitely into the
future. Any increase
in interest rates to even pre recession levels (which were also
historically low) causes Canadian real estate as a whole to appear
grossly overvalued.
Table
2 below attempts to quantify the degree of price correction
necessary to return the valuation ratio in these
five real
estate markets back to the historical average valuation ratio.
Click Here to view a larger version of
this chart.
Table 2)
Canadian home prices over
discounted rent valuation: Vancouver,
Calgary, Edmonton, Toronto, and
Montreal
- NEW
Using
the data from Chart 5 above, the following table attempts to
quantify the degree of price correction necessary to return
the
valuation ratio in these five real estate markets back to
the historical average valuation ratio. The price
corrections
necessary to return the valuation ratio to the historical moving
average
range from -40% in Vancouver, to -28% in Edmonton.
Click Here to view a larger version of
this table.
Section B
(charts 5 through 10):
Canadian Real Estate
Market Trends, Valuations, and Drivers of Home Prices
Chart 5)
Growth of Canadian home
prices in comparison to nominal GDP growth and mortgage credit
Appreciation in Canadian home prices (from January 2000 onward) has
more
closely reflected growth in mortgage credit rather than growth in
Canadian nominal GDP.
Click Here to view a larger version of
this chart.
Chart 6)
Provincial wage growth
versus home price appreciation: Vancouver, Calgary,
Edmonton, Winnipeg, Ottawa, Toronto, Montreal, and Halifax - NEW
Canadian
wage growth versus home price appreciation from 2001 to 2012 is
reported below. Average weekly wage growth per home province
of each city is reported. Also, only wages of full time
workers between the ages of 25 and 54 were examined in an attempt to
capture changes to the buying power potential of
first-time-homebuyers. In all ten markets examined, home
price appreciation far surpassed
average weekly wage growth. The markets with the largest
difference between wage growth and home price appreciation in
descending
order are: Winnipeg, Vancouver, Montreal, Edmonton,
Calgary, Ottawa, Toronto, Halifax
Click Here to view a larger version of
this chart.
Chart 7)
Canadian misery index -
National,
Vancouver, Toronto, and Montreal
The
Canadian misery index (inflation + unemployment rate) has been
climbing since hitting a low at the end of the first quarter
2008. Toronto misery is at levels not seen since
1995. All three major
Canadian cities are at or above misery levels similar to those of the
early 2000s. Canadian interim misery index (not quarter end
data)
indicates that national
misery is currently just below 10%, last seen at the end of the first
quarter
of 2003.
Click Here to view a larger version of
this chart.
Chart 8)
Canadian real (inflation
adjusted) rent index: Calgary,
Vancouver, Edmonton, Winnipeg, Montreal,
Halifax, Ottawa, Toronto
Canadian
residential rent increases have not historically kept pace with
inflation. While Canadian housing prices have surged higher,
renting
has become relatively cheaper. This is evident from the chart
below
indicating long term trend of real-rents (inflation adjusted) has been
downward in most Canadian cities. This
has implications for retirees expecting to utilize
rental income to finance long term retirement expenditures.
As
with non
inflation indexed bonds, cash flows from Canadian real estate may prove
to be ineffective to satisfy future increases in the cost of
living. This is in addition to the fact that residential real
estate
in Canada already possess low rental yields, or the net annual rental
income generated from a property dividend by the current market value
of the property.
Click Here to view a larger version of
this chart.
Chart 9)
Canadian real (inflation
adjusted) home price index: Vancouver,
Edmonton, Toronto, Calgary,
Regina, Montreal, Victoria, Winnipeg
Long
term real (inflation adjusted) annual home price returns have
exceeded 3% in Vancouver and Victoria BC, while exceeding 1.5% in
most other large Canadian cities. Edmonton is the only
exception with a
compounded annual house price appreciation of 0.64% over the examined
period. To put this into perspective, numerous examinations
of long term real
US home price appreciation
indicate that they have only slightly exceeded inflation at an
approximate annual
compounded rate of 0.5% per year.
Click Here to view a larger version of
this chart.
Chart 10)
Canadian home prices to
rents: Vancouver, Calgary,
Edmonton, Toronto, Montreal
Canadian
home prices are currently not in line with historic multiples
of residential rental prices. Most extended from historical
norms are
Vancouver, Montreal, and Toronto. While Edmonton and Calgary,
are
elevated from historic averages but below previous witnessed
highs.
Click Here to view a larger version of
this chart.
Section C (charts
11 through 18):
Canadian Real Estate
Unemployment, Vacancy Rates,
and Home Price Growth in Major Canadian
Cities
The following charts display a time
series of unemployment, vacancy rates, and quarterly home price changes
for: Vancouver, Calgary, Edmonton, Winnipeg, Ottawa, Toronto, Montreal,
and Halifax.
Chart 11)
Vancouver unemployment,
vacancy rates, and home price growth
Click Here to view a larger version of
this chart.
Chart 12)
Edmonton unemployment,
vacancy rates, and home price growth
Click Here to view a larger version of
this chart.
Chart 13)
Calgary unemployment,
vacancy rates, and home price growth
Click Here to view a larger version of
this chart.
Chart 14) Winnipeg unemployment,
vacancy rates, and home price growth
Click Here to view a larger version of
this chart.
Chart 15) Ottawa unemployment,
vacancy rates, and home price growth
Click Here to view a larger version of
this chart.
Chart 16) Toronto unemployment,
vacancy rates, and home price growth
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this chart.
Chart 17) Montreal unemployment,
vacancy rates, and home price growth
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this chart.
Chart 18) Halifax unemployment,
vacancy rates, and home price growth
Click Here to view a larger version of
this chart.
Section D
(charts 19 through 22):
Canadian and US Real Estate versus Stock Markets (TSX and S&P
500)
Chart 19) From 1977 - Canadian real
estate
versus the TSX index
Displayed
in the chart below are Canadian home prices as a ratio of the
TSX index (Canadian stock market) from 1977. Seven cities are
included:
Vancouver,
Victoria, Calgary, Edmonton, Regina, Toronto, and Montreal.
Over the
long term, home prices in Canada have
lagged price appreciation of stocks. Note, the stock index
below is a
"price index" and therefore, excludes payment of dividends.
Click Here to view a larger version of
this chart.
Chart 20) From 1998 - Canadian real
estate
versus the TSX index
Displayed
in the chart below are Canadian home prices as a ratio of the
TSX index (Canadian stock market) from 1998. Nine cities are
included:
Vancouver,
Victoria, Calgary, Edmonton, Regina, Ottawa, Toronto, Montreal, and
Halifax. Over the medium term, home prices in Canada have
outperformed price appreciation of stocks. Note, the spike on
the
charts observed at March 2009 represent the stock market bottom during
the financial crisis.
Click Here to view a larger version of
this chart.
Chart 21) From 1987 - US real
estate versus the S&P 500 index
For
comparison purposes the following two charts (Chart 20 and Chart
21) have also been
included which display US home prices as a multiple of the
S&P 500 (US stock market). The chart immediately
below displays US home prices as a ratio of the
S&P
500 index (US stock market) from 1987 onward. Fourteen US
cities are
included in the chart below as well as a composite index of ten major
US Cities. Over the medium term, home prices in Canada have
outperformed price appreciation of stocks. Note, the spike on
the
charts observed at March 2009 represent the stock market bottom during
the financial crisis.
Click Here to view a larger version of
this chart.
Chart 22) From 1998 - US Real
Estate versus the S&P 500 Index
For comparison purposes the following chart and the chart above have
been included which display US home prices as a multiple of the
S&P 500 (US stock market). The chart below displays
US home prices as a ratio of the S&P
500 index (US stock market) from 1987 onward. Fourteen US
cities are
included in the chart below as well as a composite index of ten major
US Cities. Over the medium term, home prices in Canada have
outperformed price appreciation of stocks. Note, the spike on
the
charts observed at March 2009 represent the stock market bottom during
the financial crisis.
Click Here to view a larger version of
this chart.
Section E (charts
23 through 26):
US Housing Price Performance vs. Major Canadian Cities
The following charts indicate relative
performance of US home prices
to Canadian home prices in four Canadian markets: Vancouver, Calgary,
Toronto, and Montreal. US home prices reflect Canadian
dollars by
applying a timely CAD/USD exchange rate to the US home price index.
Chart 23) US Home Prices versus
Vancouver Home Prices
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this chart.
Chart 24) US Home Prices versus
Calgary Home Prices
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this chart.
Chart 25) US Home Prices versus
Toronto Home Prices
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this chart.
Chart 26) US Home Prices versus
Montreal Home Prices
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this chart.
Section F
(charts 27 through 33):
Price and Sales Pair Volume Change for Major Canadian Cities
The following charts indicate annual
changes in monthly home prices and "sales pair" volume. Data
has been
generously made available by Teranet - National Bank for: Canada,
Vancouver, Calgary, Ottawa, Toronto, Montreal, and Halifax.
Please visit http://www.housepriceindex.ca/
for the definitions and methodologies used
calculating their indices.
Chart 27) Canadian Home Price and
Sales Volume Change
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this chart.
Chart 28) Vancouver Home Price and
Sales Volume Change
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this chart.
Chart 29) Calgary Home Price and
Sales Volume Change
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this chart.
Chart 30) Ottawa Home Price and
Sales Volume Change
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this chart.
Chart 31) Toronto Home Price and
Sales Volume Change
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this chart.
Chart 32) Montreal Home Price and
Sales Volume Change
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this chart.
Chart 33) Halifax Home Price and
Sales Volume Change
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this chart.
Pacifica
Partners - Capital Management
Navigating
a Sea of Opportunity
Disclaimer:
This report is for information purposes only and is neither a
solicitation for the purchase of securities nor an offer of
securities. The information contained in this report has been
compiled from sources
we believe to be reliable, however, we make no guarantee,
representation or warranty, expressed or implied, as to such
information’s accuracy or completeness. All opinions and
estimates
contained in this report, whether or not our own, are based on
assumptions we believe to be reasonable as of the date of the report
and are subject to change without notice. Past performance is
not
indicative of future performance. Please
note that, as at the date of this report, our firm may hold positions
in some of the companies mentioned. Copyright (C) 2012
Pacifica Partners Inc. All rights reserved.
