Perspectives podcast: Real estate market update — Uncertainty, high stakes and suspense

Stephen Meurice: When it comes to finances, many Canadians have one question on their minds. When will interest rates finally start coming down? And that uncertainty is especially felt in the real estate market. 

Farah Omran: I think it's a time where stakes are high and there's a lot of suspense. It just seems that everybody is unsure about what's coming. Including the central bank themselves.  

SM: That’s Scotiabank Senior Economist, Farah Omran.

FO: Where I'm standing, as somebody who's looking at the data from a macro level, it looks like there isn't much happening right now, but I think there is a lot of movement beneath the surface. With a lot hinging on the next Bank of Canada move and how the market will respond to it.  

SM: Farah is back this episode to give us her take on the state of the Canadian housing market. She'll tell us exactly what she sees as she dives into those numbers beneath the surface. She’ll also fill us in on new efforts to address shortages, what we might see happen in the next six months and much more.  

I’m Stephen Meurice and this is Perspectives. 

Farah, welcome back. Always a great pleasure to have you here.

FO: It's great to be here.

SM: Okay let’s get right into it, last time you were here was October and you told us the market was sort of in a wait and see state. I know there are new numbers just about to come out, but what's the current lay of the land? How have things evolved or changed since October?  

FO: In many ways, we're back to where we were in October with the stakes being much higher. So let me do a little recap since October. When I was here last time, it was after the Bank of Canada had hiked again in June and July. And so, the market was really slow for the second half of 2023. And in many ways, we expected that is because a lot of buyers were waiting for the widely expected Bank of Canada cut this year to happen so they can buy. Now, what surprised us was that we saw a jump in sales in December and January much before a Bank of Canada cut or an announcement of a cut approaching. And that took us by surprise. And we think this is because many buyers were making the bet that it would be best to buy now than wait until the Bank of Canada cuts. Because once they do, the housing market is going to rebound and prices will go up again. So it seems that the buyers were saying, ‘Okay, it's maybe better for me to take a variable rate now or a short-term fixed rate mortgage right now at a higher rate even before the bank starts cutting and lock in the lower prices because prices have not yet started going up and once the bank starts cutting, that will reduce the overall cost of my mortgage versus waiting until the bank cuts, everybody jumps back in the market and then I'm stuck with a higher home price.’

SM: So what do you mean by higher stakes? Is it that is it the gamble that people were taking both then and now?

FO: I think so. Exactly. I think right now you have two camps. There's the camp that is maybe thinking this is the time to enter the Canadian housing market because now things are slow, prices have not recovered the grounds that they lost. But that's not to say prices are low. You know, they're relatively low to the peak, but we're still around 30% above pre-pandemic. But that now feels like the new normal for people. And I think it's either that this is the time to enter the housing market and get a deal, or if you don't prescribe to that thinking and think once the bank starts cutting, home prices are not going to shoot up again and you know, things are not going to rebound in that way. Then you might be holding off. And then there's the other camp, which is just feeling uncertain. It's a very uncertain time right now. We don't know what's going to happen with the economy, with the rates. And I think it's making that decision to buy more difficult.

SM: So, things are very slow now. We've heard that for a spring market or coming up to the spring market, so far, it doesn't seem like there's a ton of activity. Are people still just waiting for that interest rate cut or are they not making that same calculation that you were talking about, where, ‘Well, if I wait until a rate cut, then prices are going to go up because everybody's going to jump back in the market.’ What's the difference now between how people were thinking about it in December or January when they started jumping back in?

FO: So, you know, I would say to that I'm actually unsure. December and January’s increases were unexpected. I would say those were surprising, to be honest. There are still some activity happening is just, you know, at the national level, on net, we had a slow February and March. But a couple of things, the housing market is typically like an up and down market. It's not typically a market that increases, increases, increases or declines in the same way. During the pandemic we did see that because there was that kind of FOMO rally activity. So you had increases adding to previous increases and then we had...

SM: And super low interest rates.

FO: Exactly. And the more people saw a buying happening and prices go up, the more they kind of jumped into the market. And then you had a bit of a correction. So we saw back to back declines in that way. But in the more normal times, the housing market is a kind of market that oscillates naturally. It's in fact negatively correlated with previous months of itself. So it's very normal for it to go up and down. And I kind of like to steer away from making big conclusions about one month or two months data changes. It went up a bit in March. It went down a bit in February, but we're kind of hovering along the lines of the long-term averages. And again, I think is just a right now things feel a bit more uncertain than they did in December and January. It could be that that demand also just like happened in December and January. So now it's normalizing a bit from that. 

SM: Right. And you talked about those being sort of national numbers. Are there any significant variations in some of the main markets across the country?

FO: There are, of course, always are variations across different markets. But I will say on net, we seem to be a bit more balanced now than we were, let's say a year ago. But there are pockets of heat in some places than others. For example, Alberta has been consistently hot, particularly Calgary. Quebec over the last few months has been showing a bit of strength. Markets there have seen sustained increases for three, four months. Now people are pointing to B.C. and Ontario as the markets that are showing softness, which makes sense. I mean, they are the markets where homes are most unaffordable relative to incomes. But also, if you dig deeper, they are the markets that drove much of the first quarter's increase. You've got Fraser Valley, I think about 24% increase in the first quarter relative to last quarter. Lots of Ontario markets in the double-digit increases. So, I feel like again, in that oscillating sense, then it makes sense that they might have slowed down towards the end of the quarter.

SM: Right. You've already talked about interest rates a little bit. Obviously, that is a huge factor in this as it is in so many other aspects of the economy. Some economists think there might be a rate cut as soon as June. Others, including Scotiabank Economics, thinks it's going to be later in the year. Do you think people are just going to continue to wait until those finally happen? I mean, we've been waiting for rate cuts for some time now.

FO: We have been. I mean, listen, last year I said people are waiting for the rate cuts and then we had this unexpected jump in December and January. At the end of the day, I think housing demand is not something you can push off forever. Housing is necessary and some people just need to buy and will buy when they need to buy. Not everybody's trying to time the market. But I do think right now it feels like making the move is scary, right? You know, either your bet is right and this is the best time to buy or you're the person who bought at peak rates and, you know, didn't capture the further declines in prices. So I do think for a lot of people, their decision is hinging on the next Bank of Canada move or at least more certainty on the next move. Right? Because I think right now, for example, in the US, given what's happening on their inflation front and the pushing forward of their rate cut is having a lot of people reconsidering what the next Bank of Canada move looks like and when it will happen. So, I think at least having more clarity on that will help people make that decision.

SM: And I guess it's an ever-moving target because of factors we don't know about. Whether it's the U.S. economy which continues to overperform, I think at some point in the past several months or the last six months or so, many people were predicting four or five quarter point rate cuts this year. I don't think anybody is saying that anymore.

FO: No, definitely not. And I mean, the crux of the matter here is that actually even the housing market will impact the interest rate outlook, right? So now there's a lot of upside risk on inflation. First of all, you've got consumption. Maybe consumption per capita is weakening. But on total, we have population growth and we have more spenders and more consumption spending in the economy. That puts upward pressure on inflation. We've got higher oil prices, we've got a depreciating dollar. And we've got as well the US, you know, as you said, the strength of the US economy as upward pressure on our inflation via more exports and more economic activity. As well as the fact that in the US they had seen a few months of softening inflation trends, which made everybody say, ‘Okay, they're about to cut.’ And then things flipped around. And now their inflation is accelerating, which gives the bank here a reason to think what if inflation here follows the same path? We've seen it softening for a few months, it could tick back up. So those are factors impacting the rate cut timing. And then, of course, if the market does end up recovering in the way that some people think that it would in this kind of rally way where prices would increase significantly, that of course, also increases inflation through shelter inflation. But also, through housing activity and the way that it spills over onto the economy and creates more economic activity. So, there is a universe in which the housing market itself rebounds in a way that pushes the rate cuts out.

SM: And in the midst of all this, there's still a lot of talk about housing shortages, about obviously, we have been talking about the high cost of housing and of rentals, all of that, the cost of shelter generally. What is the situation from a sort of housing shortage perspective? Is there new construction going on? Is it picking up pace at all?

FO: Right. We are in a situation of unquestionable housing shortages. That is the case and has been the case for a while. And I think the more time passes, the more the problem accumulates. We are at a level of starts that is above historical averages. But despite spikes, it seems to be trending downward since the summer of 2021. And that makes sense given market conditions. You got a market where we have a lot of labour shortages, input costs are really high and securing financing is also really difficult, not only because borrowing rates are high, but particularly given that it seems to be that the pre-construction market is where a lot of the softness is centered right now.

SM: The pre-construction market. What's that?

FO: The pre-construction market is when a builder starts an apartment building, for example, and it goes to the market to sell the units.

SM: To pre-sell it. Okay.

FO: Yeah, exactly. So given that the softness seems to be concentrated in that market, particularly in the condo space, it's harder for a builder to secure financing when they haven't sold a particular share of the building, for example. And also, obviously a builder does not want to start a project if they cannot guarantee demand. So I think that also is kind of another side of this coin is when sales are weak and things are uncertain. From a demand perspective, it's harder to get builders to want to build. So, construction might level down a bit this year given these market conditions. But at the same time, there are reasons to think that maybe not, given all of the government action on this front.

SM: I was going to ask you about that. I mean, housing figured prominently in the recent federal budget. Can you talk a little bit about what governments have been doing to try and address the shelter shortage?

FO: Yes, the federal government had the housing plan as a core part of the budget, and it was quite a comprehensive plan. Lots was in there so it's hard to kind of go through all of it. But measures to encourage building, more affordable units, more rental units, securing, for example, low-cost financing to encourage more rental building or to encourage investment in housing related infrastructure that is essential to create housing, to support already existing homeowners expand their units. They also have these measures to incentivize provinces and municipalities to remove regulatory barriers and streamline approvals and ease zoning restrictions. Things like encouraging innovation in the construction space. We're talking 3D printing, modular homes, prefabricated homes, as well as strengthening the labour force when it comes to construction. So training and removing barriers for newcomers with these skills to enter. So a whole lot of measures with an ambitious target of creating 2 million units over the next decade above business as usual, which is quite ambitious. So, business as usual right now looks around 200 or at most, 300,000 units a year. And with the announced targets that they have in mind, they're looking at 550,000 a year. We've never built that many. But just because the target is really ambitious, I don't think means that we should disregard it. I think this is a dangerous time for us to become cynical. I think any improvement is very welcome. Any new unit added to the housing market is useful. And I think we can think of a scenario where, okay, maybe we don't jump into 550 a year for the next ten years, but a world where this government and any following governments work towards a long-term solution to our housing problem, where we structurally change how we build and how we increase supply, so it's not a situation where, ‘Okay, I'm going to increase supply in these next three years.’ Moreso, ‘I'm going to create a system where forever and ever supply will be easier.’ So maybe we don't hit 550 from the beginning, but towards the end of the decade, that is the new normal. I like to think that that is possible and it also hinges on the government’s ability to crowd in private capital to help it meet these targets.

SM: Right. So a pretty comprehensive plan that it'll take a while for it to really start having an impact, I assume. And I guess ultimately, they're also going to need help from interest rates and those other factors that are not in their control but have a huge impact.

FO: Absolutely. Government spending on housing and efforts towards increasing supply have been, for the most part, overshadowed by market conditions. And I think that is essential towards its success in meeting these targets.

SM: Okay. So You said something in a recent report I want to quote back to you here. You said: “Let’s face it, everyone seems unsure...” And you go on to say, “It’s not exactly a very easy economic environment to make a very, very, big financial (and emotional) decision. It’s stressful on a normal day in regular times.” Do want to elaborate on that? I guess you’re getting into the psychology really of it at that point. 

FO: Yes. I mean, who finds buying a house not stressful? It's a big undertaking. And it's not just that it is a financial undertaking, it's this constant wondering whether you made the right decision at the right time. We kind of just live in this situation where it becomes about making a good bet and the right decision at the right time rather than having a home that you're happy in and a roof over your head and maybe with your family. So, I think that really raises the stakes of the decision in a way that is maybe not very useful, because at the end of the day, you know, people should buy a home when they need a home rather than try to make the decision at the best of time. It's really, really hard to time the market. And again, right now it's just seems that everybody is unsure about what's coming. Even including the central bank themselves have significantly revised their forecasts in their last monetary policy report, for example. So when you're seeing, you know, a central bank that they themselves may be look unsure on when to move next and everyone's unsure about the outcomes for the economy, it's really hard to make this kind of a decision.

SM: Yeah, for sure. We've had people on the show talking about investing and always advising against trying to time the market when you're investing your money. And I think maybe a lot of people think about buying a house almost as a form of investment as opposed to like the place where they're going to live and maybe raise a family or whatever.

FO: Exactly.

SM: And finally, can’t let you go without asking you to break out your non-existent crystal ball. What’s it going to look like for the next six months or a year?

FO: You know, I really wish I knew. Sometimes I feel like I would be much better at my job if I knew what was going to happen.

SM: [laughs]

FO: Maybe I don't need a job if I knew what was going to happen. 

SM: [laughs]

FO: But what I do know is that housing demand is there and will continue to be there. People will always need a place to live. We have a growing population with or without announced cuts to immigration targets. We're not ever going to be a not-growing population and people will need homes to live in. So, in that sense, demand will always be there. We evidently have a supply problem. And so, I think housing will continue to be a big conversation, a big national conversation and a big dinner table conversation. I don't think that's going to change any time soon. But if I were to be more speculative in the short term, I think there is reason to believe that there is pent up demand. Sales have been below long-term averages at a time when population is growing at a record pace. So, these two things you would think typically need to be connected with each other. And so far, we're not seeing that really happen in sales data. Again, it's a very uncertain time and I think it makes sense that people are not jumping onto the market on mass right now. But there are reasons to believe that once things look more clear and rates are lower, that there will be demand returning to the market. But I don't think we're going to go back to COVID-like demand. And I don't want us to. I don't think that was a good time for the housing market or for Canadians on the whole. 

SM: Farah, thank you so much for coming. I really appreciate it.

FO: Thanks for having me.

SM: I've been speaking to Farah Omran, Senior Economist at Scotiabank.