Earlier this week Maclean’s released their popular Chart Week post. The article highlights 91 of the most important charts to watch in 2018. There were some excellent charts relevant to the Canadian housing market which i’ll summarize below.
Here are some key charts to watch in the Canadian Real Estate space for 2018:
(Thanks again to Maclean’s)
Higher Mortgage Costs Are Coming
Ben Rabidoux is a great follow on Twitter (@BenRabidoux) with excellent research and analysis on the Canadian lending space.
“Since the early 90s, Canadian homeowners have seen continuously decreasing monthly mortgage payments at renewal. By our calculation, for every $100,000 borrowed, consumers have seen payments drop on average $91 per month for a standard 5-year fixed rate mortgage at the end of their first term due to prevailing interest rates that have been progressively lower than at origination. With the recent rise in rates, we’re now at the point where the average consumer is seeing monthly payments rise at their first renewal, something we haven’t seen on a sustained basis since the early 90s.
Granted, household disposable income was rising at a 5.2 per cent year-over-year clip as of the second quarter (the highest rate in seven years) but rising indebtedness has meant that the share of disposable income devoted to debt repayment remains 130bps above long-term norms. Canadians don’t have a ton of wiggle room here.
Skeptics have long underestimated the resiliency of the Canadian consumer, but this may finally be the year when they tap the brakes. In addition to rising mortgage payments, house price appreciation is rapidly decelerating nationally according to the MLS house price index. Along with that, new mortgage rules coming into effect in January will see homeowners who wish to refinance have to ‘stress test’ against a higher qualifying rate. This could significantly curtail ‘home equity extraction’, an important driver of household consumption both directly and indirectly by freeing up income through consolidating higher interest consumer debt into lower cost mortgage debt.
This warrants close attention, particularly since household consumption remains near a record share of GDP and has accounted for just under 70 per cent of real growth over the past 5 years.”
Rising Unaffordability Linked to Recessions
Ownership Transfer Costs as a Percentage of GDP at Record Levels
“Understanding residential investment is crucial to understanding the economic cycle. Since 1960, its weakness has explained fully two thirds of the decline in real GDP during Canada’s recessions. Digging deeper within residential investment our analysis reveals that the subcomponent that punches most above its weight during these downturns is ownership transfer costs, which is predominantly comprised of real estate commissions. Our chart shows how this key vulnerability for Canada’s outlook soared to nearly 2 per cent in the first quarter of 2017, but has begun to inflect lower in recent quarters, much in the same way it did in the United States in late 2005 and 2006. For Canada in 2018, we anticipate this downward momentum will persist as housing headwinds become more severe, a consequence of i) the BoC’s twin rate hikes during 2017, ii) the astonishing rise in the Government of Canada five year yield and associated impact on mortgage rates, and iii) the implementation of OSFI’s stress test on uninsured mortgages in January.”
Record High Housing Construction Boom
“Driven by soaring prices, homebuilding has come to occupy a record share of total economic output in Canada. In 2017, residential investment’s share of Canadian GDP far exceeds the level reached in the United States at the peak of its housing boom. If residential construction were to quickly return to its historical average of 5.9 per cent, the decline would shrink GDP by almost 2 per cent. If construction stopped as a result of sharp house price declines, the erosion of household wealth and consumer confidence would significantly curtail spending and push the economy into recession. Such a scenario can be avoided if policy makers can deflate the housing market slowly and give the fundamentals of household formation and income growth time to catch up.”
Household Consumption Is Driving The Economy
This one is important. Households are spending and much of this has to do with increased home equity spurring consumer confidence. Savings rates are plunging and household debt levels are at record highs but consumers don’t appear worried thanks to rising home equity. Consumer sentiment could reverse drastically if house prices drop.
“How long can Canadians keep spending like this? Recent figures from Statistics Canada show household expenditures now comprise 58 per cent of the country’s total output — the highest proportion in data going back to 1961. The second and third quarters of 2017 combined saw the strongest household spending contributions to growth since just before the 2008-09 recession.
One consequence is less money being put away for a rainy day. Canada’s household savings rate has averaged just 3.1 per cent over the last year, the lowest in nearly a decade. With interest rates expected to climb over 2018, economy watchers and policy makers will be closely monitoring how and if Canadians start tightening their belts—and how that affects the economy.”
Canadian Shadow Banking is on the Rise
“Canada’s shadow banking sector, which is comprised of those companies that have more flexibility in providing lending arrangements than the banks, has become a key component of our economy. According to the Bank of Canada, shadow-bank lending has grown to represent roughly 40 per cent of the traditional banking sector and over $1.1 trillion in liabilities.
The role of this sector is growing in importance given the move towards tighter mortgage lending requirements being imposed on the Canadian banks. Additionally, it provides a liquidity option for the banks to offload their higher risk mortgages thereby improving their balance sheet positions. Many have considered sub-prime spin-outs but not surprisingly there has been little interest after being tainted from the financial crisis.
All of this is contingent on a rising housing market to substantiate loan-to-value ratios, and a halt to the interest rate hikes by the Bank of Canada. However, there was some serious trouble this past summer among one of the largest lenders in the space but a solution was found at the wire to help stabilise the situation.
We created the following market cap weighted index of publicly listed shadow bank participants compared against the Teranet-National Bank Housing Price Index. Both need to remain very stable in the year ahead otherwise seriously risk impeding our economic growth which appears to have gained some momentum. Compounding matters is the record setting amount of leverage Canadians are currently onboarding, so it wouldn’t surprise us to see our shadow banking sector continue to gain market share and further increasing our country’s exposure to poorer quality debt.”