By Guest Blogger Ryan Lewenza
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One of my favourite TV shows in recent years has been Arrested Development. This hilarious program centered on an odd and dysfunctional family, the Bluths. From this motley crew, Gob Bluth, the eldest son and magician of the family, is my favourite character in part due to his signature line, “I’ve made a huge mistake”. He would say this line repeatedly as he made a lot of mistakes and I feel it’s very appropriate right now for some home buyers.
I believe many of the people moving out of the city core and into the suburbs in search of a bigger home, a backyard for the new dog and a room for the Peloton bike are going to be repeating this line (‘I’ve made a huge mistake’) in the coming months and years as we get vaccinated and reach herd immunity.
Many people are making these life-changing decisions based on a pandemic that is temporary in nature. I believe six months after we reach herd immunity, employers will be asking their employees to come back into the office. Many fleeing out to the suburbs are under the impression they will be working from home for years to come but may be pretty bummed out when they have to return to the office and their commute goes from the bathroom to their spare bedroom/office to an hour ride on the train or in the car.
I believe these Covid-induced moves are definitely contributing to the recent insanity in the markets.
Both prices and sales activity nationally have been off the charts in recent months. According to the January market update from the CREA, sales were up 35% Y/Y in January and the average national sale price of homes in Canada is up 23% Y/Y. That’s crazy given the cloud of the global pandemic and all the economic carnage that it has brought.
Home Sales Have Surged in Recent Months
Source: CREA
It’s clearly not fundamentals that are driving this housing market surge as: 1) the job market blows with the unemployment rate still at a high 9.4%; 2) immigration slowed to a crawl last year (184k new immigrants in 2020 down from 341k in 2019); and 3) home prices are up over 20% Y/Y so clearly there’s no bargains right now.
Well, what is driving this insane housing market?
Easy, record low interest rates!
My father would often say, “Son, when I bought my first home my mortgage rate was 18%!” Well dad you were born in the wrong decade as today you can get mortgage rates for 1.8% and lower. It’s not much more complicated than that.
Below I chart the MLS Composite Home Price Index for the Canadian housing market with the Government of Canada (GoC) 5-year bond yield. This is always the most important interest rate to follow as 5-year fixed mortgage rates are based off this level.
Notice two important trends. First, the long-term trendline of interest rates (dotted green line) and the long-term rise in the Home Price Index (blue line). People always ask me why home prices keep going up and I just continue to point to the trend of declining interest rates. Second, on a shorter term basis, note the big drop in the GoC 5-year yield since early 2020 when the pandemic hit. It dropped like a stone from 1.5% to a low of 0.3%. Not surprisingly, this has completely corresponded with this swift and strong increase in home sales and prices.
Declining Interest Rates Has Helped Drive the Canadian Housing Market Higher
Source: MLS, Bloomberg, Turner Investments
With home prices up over 20% Y/Y and prices hitting new all-time highs, the obvious question is, can this continue or will prices deflate faster than Piers Morgan’s career?
I’m in the latter camp and here’s why:
- First, interest rates have bottomed and will slowly move higher as the economy and inflation pick up. We’ve already seen the GoC 5-year yield nearly double in recent weeks and this is just the start. I could see the GoC 5-year yield easily hit 1.5-2.5% over the next few years. If declining interest rates have been the main driver of our housing bubble, then rising rates should take some of the bloom off this rose.
- Second, with the big move up in home prices, affordability has deteriorated and is now back at early 1990 levels, when the last major housing downturn occurred.
- Third, the Canadian home ownership rate sits near a multi-decade high of 67%. Meaning, most people who can afford or want a home are already in the housing market.
- Lastly, rent prices have dropped the most in decades, making the rent/own debate a tougher call. According to the rental property website, Rentals.ca, the average rental price nationally is down 8.7% Y/Y and here in Toronto is down a staggering 22% Y/Y. Our head trader just rented a 1 bedroom plus den in a hip downtown condo for $2,150 including parking and storage, which would have gone for $2,700 pre-Covid. Renting is looking a lot more attractive these days.
Now to conclude, I’m not calling for some massive crash in the Canadian housing market as that would require significantly higher interest rates, which I don’ t believe is in the cards, in the medium term at least. But I do see interest rates moving higher as the economy and inflation pick up, which should help to take some froth out this unprecedented bull market in Canadian home prices.
RBC Housing Affordability for Canada
Source: RBC Economics
Ryan Lewenza, CFA, CMT is a Partner and Portfolio Manager with Turner Investments, and a Senior Vice President, Private Client Group, of Raymond James Ltd.