Perspectives podcast: Real estate update — Ups, downs, and still out of reach for many

Stephen Meurice: In the past we’ve described the Canadian real estate market as a rollercoaster. But over this past spring and summer, maybe a more apt metaphor is a trampoline? 

Farah Omran: Right, like prices are going down and up and down and up. I just had this image of a trampoline. 

SM: That’s Scotiabank Economist Farah Omran. But she says, actually maybe it's more like a trampoline on top of Mount Everest? Because sure, it’s bouncing, but...

FO: In a range that is just too high to have a material impact for households who are actually trying to buy. Because the downs and ups are in a range that is unaffordable. 

SM: And that’s the Canadian real estate market in 2023. Ups and downs, but still out of reach for many.

John Webster: Absolutely, we have an affordability crisis in Canada right now. 

SM: That’s John Webster, Scotiabank’s Head of Real Estate Secured Lending. 

JW: Millennials, particularly are getting very angry about how difficult it is to buy your first home. It's a hot button. 

SM: John and Farah are back on the show today to help us get our heads around those hot button issues in the housing market. They’ll give us details on the latest ups and downs, affordability, as well as the impact of the latest hikes and holds from the Bank of Canada. And where all this might be headed. I’m Stephen Meurice and this is Perspectives

John, Farah, welcome back to the show. 

JW: Thank you.

FO: Good to be here.

SM: Before we get into this, I think this is our seventh time that we've all been together. John, I understand there's some big change coming in your life.

JW: There is. I am retiring from the Bank at the end of the calendar year.

SM: How long have you been with us?

JW: Almost 18 years.

SM: Wow. Big retirement plans?

JW: I might start my own podcast.

SM: You’ve got to have Farah and I on as guests.

JW: Absolutely. First guests.

SM: Absolutely. No retirement plans for you, Farah?

FO: Unfortunately, no, not yet. I'm working on it. [laughs]

SM: Alright, so we can count on you coming back at least, Farah.

FO: Oh, yes. [laughs]

SM: John, are you able to tell us anything about who's going to be filling in for you?

JW: Tracy Gomes will be taking over as the head of Real Estate Secured Lending. And in fact, we've begun the introduction. So over the next several weeks, she will be introduced to the industry and to our stakeholders and partners.

SM: So she's in training for coming on the podcast, is what you're saying.

JW: I'll leave that in your capable hands.

SM: [laughs] All right. Let's get into it. As I said, this is your seventh time on the show. We have a tradition where I started off by asking Farah for a headline and she says, I put her on the spot, but then she always comes up with something great. So Farah, what is the headline around the markets these days?

FO: I will say that the market is currently in a ‘wait and see’ approach. Two months ago I was saying that the market is playing trampoline and we can get into that later. But I think there's a lot of uncertainty right now.

SM: John, headline? 

JW: Anger. Affordability is a hot button, particularly for millennials and new Canadians, and it's becoming a louder and louder voice. And I suspect that shall continue over the next many months.

SM: All right, Farah, maybe you can tell us a little bit about what you're seeing, the specifics of the numbers around sales and prices. And we'll get into the supply and the issues driving some of those problems that John was just talking about. But give us the lay of the land for now, Farah, around what you see.

FO: Right. So I think the last time I was here was in May. And at that point we were just starting to see an uptick in sales activity after the year of a correction that we've seen since the bank started hiking last year. So the bank started hiking last year and we had 12 consecutive months of price declines and declines in sales activity, and all of that good stuff. And as the year started, 2023, around February, we started seeing that story change. We start seeing small upticks in sales for a couple of months and then April comes around and we have a staggering double digit increase and that continues on for a couple of months. While listings during the time were just declining by also big amounts, they only started increasing in the last couple of months, the duration of when sales were increasing, but it was nowhere close to catch up with the uptick in sales activity that we saw over that period. And so we saw prices after again, 12 months of declining, just completely reversing and recording very high increases like as high as we were seeing during the pandemic rally of 2% a month, which is quite significant for the home price index to increase per month. And we saw three of them in a row and that has gotten smaller over the last couple of months, the increase in prices, because we've actually seen sales take a corner again and decline again while listings still were playing catch up and increasing. We can get into the reason of why sales started declining the last couple of months. That's largely due to the Bank of Canada resuming their hiking cycle. We know they hiked in June and July and they left the door open for more hikes, if things require them. And that hike in itself was partly driven by the increase in sales that we've seen early this year that kind of drove the bank to hike because it couldn't afford the most rate sensitive sector in the economy to roar as it was when it was trying to actively slow down the economy and bring inflation back to 2%. So by hiking for June and July, obviously there's the direct impact of higher borrowing costs. Households were not as able to borrow to afford homes, but I think the bigger impact was the uncertainty effect, because once the bank started hiking again, it kind of signaled to households that a pause is not necessarily an end and that there's a lot of uncertainty in terms of the outcomes for the economy and inflation and rates. It just brought that to the forefront for households. You know, even the bank is unsure how things are going to develop, when prices pressures are going to re-emerge again and when they're going to start hiking again. And I think that pushed a lot of people to the sidelines wanting to wait and see what happens. Is there going to be a recession? Is there not inflation going to stabilize? Is it not? So that's where we're at right now.

SM: All right. So lots of different factors going into this. But John, Farah talked about a sort of pause in the price increases and the number of sales that are taking place. What do you think is driving that?

JW: The market currently is very slow, but let's go back to that May podcast. At that time, there was a resurgence. There was a bit of a lift because people had more hope. Rates had topped out and prices weren't moving down. So buyers who could afford to get into the market got back into the market. Soon as those two rate increases came, that market died. So it was a little bit of a resurgence — I don't know if that's what you meant by the trampoline —where the price is going back up. 

FO: Yeah. 

JW: But interestingly enough, I mean, you have to remember, Stephen, we always point this out that as rates went up, the qualifying rate still adds on two percentage points to qualify. So while that's in place, it makes it doubly difficult. People coming up with a down payment is still a challenge. So those are the issues that people are struggling with. Financial uncertainty has played a big factor. Potential vendors have been sitting on the sidelines and they continue to sit on the sidelines. I think that as soon as rates start — now they've stabilized. If there is another increase, it'll be deferred. But ultimately those potential sellers will get into the market because they've seen the price point almost approximate what the height was during the pandemic. So people are looking and saying, well, I can get a pretty good price for my house. Maybe it's time to list. Borrowers are still that I speak with and the data that I look at, particularly millennials and New Canadians want to buy. So realtors will tell you this: they've got a list of people they talk to that want to sell and they've got a list that want to buy. So in my view, once rates have stabilized and started to go down, you'll see a big pent up demand like the trampoline effect that Farah mentioned last time.

SM: Right. Because we hear constantly about housing shortages in this country. But if the number of sales are going down, it's not because the demand isn't there, this is strictly an interest rate.

FO: Yeah, I mean, it's an affordability situation in which interest rates play a part and it's a supply situation too. If sellers are not participating in the market, there's not much for people to buy. But you notice that even though, you know, when the June and July hikes came in and killed this resurgence in activity, prices have still increased during this time because there is a fundamental imbalance in the market. Now, this has been getting smaller and smaller each month that sales are declining and listings are going up. But it just points to these imbalances.

JW: But the price of house is in August, as you pointed out, your forecast went up.

FO: Yeah, it went up. It was the smallest in the past six months, but still enough when sales went down by like what I forget now 5% or something.

JW: Sales were down, prices were up.

FO: Yeah. Listings were up too.

JW: The demand is overwhelming. We've talked about this previously. There are so many new household formations through immigration, through international students. The pressure on rental stock, the pressure on housing is enormous. StatsCan miscounted how many people there actually are new people in Canada? I think there's over 2 million people in the pipeline to become permanent residents, and we're more than two and a half million houses behind and we might have 250-260,000 current housing starts. So that's got to flip over. We've got to start to see much more new build. We've got to see continued emphasis on streamlining the whole process to get more dwellings built much faster.

SM: All right. We'll get to that supply question in just a minute. But Farah, given that pent up demand that John was talking about and a shortage of supply, there might be a little bit of price stability now, but just given those market forces that are there, the affordability of housing is not really going to change for the foreseeable future really?

FO: Yeah, barring an unforeseen event in which, you know, a big recession happens, a wide crisis occurs, which is not in anybody's baseline forecasts right now, it doesn't point to an improvement in affordability and this is actually the trampoline effect that I was trying to talk about, where the media focuses on a month's figures. Right? If prices go up, we start talking about prices going up. If prices go down, we start talking about prices going down. But in reality, when the correction happened, since the banks started hiking in February of 2022, sure prices started adjusting down. And what we saw is that prices were going down the most in cities where they had gone up the most during the pandemic. And then when we saw an uptick in sales activity earlier this year and prices started going back up, we're seeing kind of the same exact thing just in reverse. Prices are going up the most where they had corrected the most in the past 12 months. So I just had this image of a trampoline, like prices are going down and up and down and up. However, in a range that is just too high of a material impact for households who are actually trying to buy because the downs and ups are in a range that is unaffordable.

SM: Right.

JW: Typically when you have house price depreciation, it's driven by increasing levels of unemployment. So you'd have to look at a major recession really to look for house price depreciation. But we've had the opposite, including in August, where there was a bigger inflation print with greater job creation numbers and they were largely in the self-employed. But that speaks to the underlying health of the economy. So it is a strange circumstance where everyone in the media had said, well, what will happen is the prices will start to depreciate. The challenge for both potential buyers and vendors, you know, you can't out-guess the market, so people have become conditioned, as Farah said. If it wasn't for economic uncertainty, I think you would see more listings.

SM: Farah talked about that, the price being sort of within a band. So it moves a little bit one way or the other. It bounces a little bit up and down, but it's still for the average person, especially a first-time homebuyer trying to get into that market, still it's a frightening space.

JW: We have an affordability crisis in Canada right now. It's serious and all levels of government are seized with it. Millennials, particularly are getting very angry about how difficult it is to buy your first home. And that pressure will continue on all levels of government going forward. It's become a ballot box issue. It's a hot button.

SM:  Yeah. And I mean, you deal maybe not on an individual basis, but you're very connected to those people who are looking to buy a house. What do you hear about the mood out there? I mean, you mentioned anger, but in terms of specifics, what do you or the brokers tell people around “this is how much money you need” or “interest rates are going to go up and down”? Like what can you even tell one of those millennials about the possibility of being able to buy a house?

JW: Well, the challenge for a lot of intermediaries is that they had so many really buoyant years where the market was so strong. So a lot of them were high producers, were not accustomed to seeing this downturn in terms of the number of ends that were sold every month. And so their businesses have all been impacted. I would say that they're looking for hope and optimism and everybody is looking at the interest rate environment saying please don't go up. One will go down and trying to predict when that starts and positioning themselves. I think most people who have their ear to the ground talk to people who are active in the market every day. They feel that pent up demand. So they know that there's going to be a lot of activity as soon as rates turn down. But as you read in the paper every day, does the bank pause? Is the bank saying, well, maybe one more time? Farah mentioned that the critical rate, you know, in terms of the target rate’s 2% and it was at 4% in August. But a lot of that it's a little bit misleading. A bunch of that is mortgage payments going up. Right. And the other part is fuel and groceries, I guess to a lesser extent. But in terms of that basket of goods that they look at, people are trying to gauge when is inflation going to be manageable enough that rates can come down. And I don't think that we're going to get there as soon as people are going to start to become much more vocal, expressing their frustration about why has this been allowed to continue. You've already seen the current federal government pivot and start to address this. You seen the opposition just hammering them on affordability in paid ads every day.

SM: Yeah. And on the interest rate question, every time you think I mean, there were there was a pause, but then you get some unexpectedly high inflation numbers come out and now people are talking about maybe it'll be another increase in October. What is Scotiabank Economics’ view around the interest rate situation?

FO: Well I mean, right now our last forecast, which came out in September, had the bank at the end of the hiking cycle and cutting not anytime sooner than next spring, but since then we had...

JW: Spring of 2024.

FO: Yes, but since then we've had quite a positive shock on inflation. We had an inflation print that was stronger than anybody expected, not just us, including the Bank of Canada. Now, of course, much of that comes from food and energy. We know that energy prices have been going up because of production cuts and other issues. But still, our baseline forecast, we did say that right now, given our forecast of core inflation measures, we see that this is the end of the hiking cycle. But we did say that if core measures accelerate, then the bank might need to hike again and, you know, obviously one month data point is not going to be the information that we need to answer that question. We're going to have to monitor inflation over the next few months. But if things start accelerating again, then the bank might need to hike again.

SM: All right. Let's get to that question around supply that you both mentioned. But Farah, are there any numbers around what the new build situation is in Canada? Does it look like there's any improvement there? Are more houses being built than there used to be.

FO: So relative to historical levels, the starts are high, but we still saw the trend and start activity decline over the last little while. It's still above historical standards, but it didn't hold up at a level that is closer to what we need to fill the supply shortage. Now, the last couple of months saw a bit of an uptick. In July, of course, was the wettest July in history. So seasonal adjustments don't account for that. So even when you look at seasonally adjusted data starts declined a bunch in July because of that. There has been a bit of an uptick in August, but it did not recover all that ground. And we see that in construction employment as well. We saw employment plummet in July and the construction industry and again August recouped some of that, but not entirely. But when you look at the investment and residential construction as they go into the calculation of GDP in the national accounts, those have been declining for a couple of quarters now, declining quite significantly, actually, which does not bode well for housing construction. And there's a lot of reasons for that. You know, materials are expensive, labour is expensive. Labour is also in short supply. And it's also hard to secure financing for construction. Rates are really high, and again, there's a lot of insecurity. As a developer, you might want to wait and see what's going to be happening over the next little while before starting a new project. And also, you know, developers follow demand. If they're unsure about where demand is going, they might be unsure whether they want to commit to a project or not. So relative to historical standards, yes, starts look high, but I don't think they're anywhere close to fix this problem in the foreseeable future.

SM: So a lot of factors working against the builds that we need. John, you mentioned that CMHC report saying we need 3.5 million units above what we already have planned to build. You also talked about it becoming a political issue and there have been announcements recently around the housing market. Do you see hope in time that some of the measures that are being taken?

JW: I take encouragement from the public discourse that typically I would have told you that when you read what's written in the media, as Farah said, it's very short term and real estate’s a long cycle, whether you're building condominiums, going to get registered five years out, anticipating demand. So you have to look at it from that point of view in terms of you can't look month to month. So I think in terms of the public discourse, there's been more light than heat where it's typically I think that there's been more heat than light on most of the discussion around what are the causes of the housing shortage, affordability. All governments are seized with it. Ontario and B.C. have been probably the most active as provincial governments driving change. All of them are putting pressures on their municipalities to improve the approval process, speed it up. We've had recent changes in Toronto, Vancouver in terms of allowing more density on a single family dwelling where only one would have been allowed. Now on your lot, you could have four potentially. So all of those things are good steps, but they're small steps. The challenge is that the gap between where we are and where we need to be is so wide and you just can't do enough and we're not going fast enough. So I think that the political pressure that is going to build is going to be very difficult for the Bank of Canada, too, because while they're independent, the screaming is going to get louder and louder about affordability and where can I live? And, you know, average rentals are over 2000, doesn't matter a month where you live in Canada. So this is a challenge that governments have to meet. And I think that they need to have a more coordinated action. A national housing table where the municipalities, the province, the feds are represented. The stakeholders, the banks, the lenders, the developers. They really need to make common cause to fix this problem. You've seen recently in the media talking about the origins of CMHC. Why did it come to pass? It came to pass to build housing for veterans returning from the Second World War. Can you imagine that? We're talking about this like it's on a wartime footing because we've screwed up so badly, the supply side. And the whole focus on a regulatory point of view has been to dampen down demand. And that hasn't worked.

SM: Right. Can I just ask you, because you see this from up close with the way interest rates have gone up over the past year and a half, how are homeowners dealing with that, mortgage holders?

JW: Well, I think the people that took the variable we talked about, variable rates were so low February ‘22, all time low, and they've had rapid increases. And in our case, our payments do go up with the bank of Canada changes. In other institutions, they don't. What we've witnessed in that cohort of people that Farah mentioned February ‘22 high watermark for prices, low watermark for rates. We've observed the interest rate shock among our variable borrowers and they've been very responsible. In fact, it's interesting because you look at their discretionary spend, they do what you think they would do. You know, they're not going to go out as much, spend on restaurants, won't go with Farah to concerts, she's going to have to say, please come, I want to go out. And they're saying, no, I got to make my mortgage payment. I'm saying make your mortgage payment. 

SM: [laughs] 

JW: You know, I've got a couple of children that are in that circumstance where their payments are going up. And the reality is that you have to cut your expenses in order to meet those obligations.

FO: Yeah. And it does seem actually, when you look at data, typically it is the case that mortgage payments are the last that households default on when they have that expense. So in a way, an ideal scenario of a soft landing would be where they cut all the other spending except for that and that —

JW: Except for concerts and mortgage payments.

FO: [laughs] Except for concerts. And so consumer spending would decrease. That would put slightly less pressure on prices, open up some disinflationary slack in the economy. Inflation goes back to target, but there's not a full-on financial crisis.

SM: Which is a great segue into the last question, which is to get you guys to each take out your crystal ball and look ahead six months or so and tell us what you see. What do you think it looks like, Farah?

FO: So I tripped on the way here and I broke my crystal ball, so I don't know. 

SM: [laughs]

FO: But let's look at what we know. We know that we are going to have a strong population growth over the next six months. We know that we already have a shortage of supply and no projects are going to get started and completed within these six months. We know that economic growth is stalling and we know that we're not forecasting a full-on recession. We're forecasting a stalling. Rate might still go up a couple of times, but either way, they're near the levels that they're going to end at. So we can see a clear scenario of demand. There will be demand from the strong population growth. People are going to need places to live, whether it's rental or whether it's owned. People are going to need these homes and we might see a little bit of a price decline, slight uptick, you know, let's say stabilization of prices for a bit. But it's in a case where our baseline forecast is what actually materializes and there is no recession. It's looking like there will be demand for homes and there's not enough supply to meet it. And that will put pressure on prices.

JW: We also know that from the measuring the attitudes of first-time buyers, potential buyers, millennials, new Canadians, they want to own a home and they want to get into the market and they're fairly passionate about it. So I think that it's difficult to say when will rates, not only if they flatline, when will they decreases as the back half of ‘24, but it's going to happen. And I anticipate that the spike in demand will be much, much greater than people anticipate. That psychology, once it starts to go down, people will get into the market in much bigger numbers than people anticipate. And whether it happens, you know, in the spring or if it's a little later, to me, the seasonality won't be the issue. The issue will be that pent up demand will get unleashed, not unlike what happened during the pandemic for other reasons. And rates were so low, it'll be more tempered, but it will be a big push in the market.

SM: So the supply issue will become even bigger as time goes by?

JW: Absolutely. All of the measures that have been taken to date, in my view, are at the margins. So what we need is something that will shift materially, that imbalance. It's dysfunctional right now. The supply demand imbalance is structural and it's going to be there for many years to come, in my view.

SM: I want to thank you both. It's always a pleasure to have you. And John in particular, thank you for your many appearances on the podcast. I really appreciate you taking the time with us and all the best for your retirement.

FO: Yes. We're going to miss you.

JW: Well, it's a pleasure. It's been a lot of fun. Thank you.

SM: I've been speaking with Scotiabank Economist Farah Omran and John Webster, Scotiabank's head of Real Estate Secured Lending.