Perhaps one of the biggest surprises from last year was the boom in the housing market. If we went back in time and asked “what would people do if we had a global pandemic that lasted over a year and forced us to close the economy and lose millions of jobs?” few would answer “Buy homes in record numbers”, but that is what they have done. Housing prices in almost all markets have skyrocketed, as I’m sure you are all aware, and the reasons are also probably no secret. Ultralow rates, government stimulus payments, low supply, demand detached homes over condos, Work From Home effects on markets outside of major cities, FOMO etc. Some quick stats…
- The benchmark Canadian home price was 20% higher in March than the year before, an extra $120,000 on average.
- Resale activity is up 76% over the same time across Canada, and it was even up 5% just from February to March.
- Canada’s MLS home price index grew at the fastest year-over-year pace ever…single family homes are up 25% (condos up 5.4%, highlighting were COVID demand is)
- New listings hit a record of 1 million (annualized) in March, and rose in every market except one (Victoria).
- Home resales set a record in 2020, and as of march we are 50% above that record 2020 pace, again on an annualized basis. A few markets saw a decline but that was due to a lack of single family homes for sale, not a lack of demand.
Clearly, this is a seller’s market. Clearly, this is a red hot bubble. Clearly, this kind of pace cannot continue and may in fact even signal some sort of impending problem… Right?
Those statements are certainly the popular point of view. Many are becoming frustrated with housing and the lack of affordability (more specifically the supply of affordable options) and the opinion that housing is too high if often paired with an emotional desire to see some sort of major correction. When opinions appear to become one sided I often like to ask what smart arguments exist for the other side of the coin. This week, I want to explore some reasons why the housing boom can continue, and why it may not appear to be as overvalued as you may think.
Before diving in I want to clarify a point…this exercise is meant to strengthen one’s views on the subject, not necessarily change one’s mind. What I am about to share is work done by someone other than me. It does not mean that I am suggesting one side is right and the other wrong, I simply want to present both sides of the argument. Perhaps what you are about to read will change your mind, or perhaps you will find it less than compelling and therefor strengthen your current opinion. Either way, that is a better outcome than holding a strong view on a topic that you are only partially informed on. There is not much discussion of why the housing boom could continue, so I thought this would be a good topic for Weekend Reading this week.
Brian Wesbury is the chief economist at First Trust and a very outspoken fellow. He has made a name for himself by cutting through the noise and interpreting data in a way that can sometimes run against the popular or political backdrop, and importantly he has been quite right a number of times over the past year. His recent note is titled “Housing Boom to Continue” and what follows is a summary of the data he presents to back that position up. This will have to do with the US housing market, which is also red hot, but I will tie in some Canadian info as well.
The US Case Shiller housing index is up 11.2% in the US, which is the largest gain since 2005-06. The Federal Housing Administration index is up 12%, which is the largest gain since the index began in 1991. These statistics raise the same questions in the US as they do here, but Brian looks at home prices a different way. He takes the market value of all owner-occupied homes which is calculated by the Federal Reserve and compares that to the “imputed” rent calculated by the Commerce Department for its GDP report. Imputed rent is what you would have to pay to rent your home if you didn’t own it. Over the past 40 years home values have averaged 16.4 x annual rent, peaking in 2005 at 21.4x annual rent before that bubble burst during the GFC. Currently, they are 17.8x annual rent, or only 11% above normal by this measure.
From another POV, he compares home prices to the Fed’s measure of replacement cost. In the past 40 years homes have averaged 1.59x their replacement cost. In 2005 they peaked at 1.94x, today they are 1.63x. During the 2000’s bubble they were 22% above normal, today they are 2.5% above it. Hardly a bubble, according to Mr. Wesbury.
So if prices are not overvalued, why is the housing market running up so fast? The answer is supply, or rather a lack of it. Based on population growth the US needs housing starts (construction of new homes) around 1.5 million per year. In the past 20 years builders have only started 1.256 million per year, and starts have not been above 1.5 million since 2006. The result is low inventory, to the tune of only 870,000 existing homes being for sale in the US in February. In comparison, between 1982 and 2016, the lowest February inventory on record was 1.55 million. Thanks to Covid there are only 40,000 completed new homes for sale now (77,000 a year ago pre-Covid), but the average for the past 20 years is only 87,000. Far below demand.
Brian points out two other fundamental reasons he believes the housing market should continue to be strong, beyond just supply constraints.
1) There is still a moratorium on evictions and rent increases, so some tenants are paying less rent than they normally would. This temporarily holds down rental values vs home prices as well as the housing component of CPI (which is calculated using rents and not home prices). Higher rents will create more incentive to buy, both for current renters that can afford it and investors who can earn a higher cash flow. This is true in Canada as well.
2) People are moving away from places where renting is popular to places where home ownership is more common. Think New York to Montana. This move helps boost home prices and is a reason the gains are broad and not just in concentrated markets….this is true in Canada as well. Markets once considered sleepy are very strong, as people leave the city centers for a combination of value, work from home capability, lifestyle, health safety and affordability. Anecdotally, I have seen this in droves for the last few years. Friends in my age cohort are leaving the city in favor of Victoria, Nanaimo, Kelowna, Kamloops, or another province all together like Alberta or Halifax. To start or raise a family you usually want to be able to afford a backyard. Clients have also retired to those same areas in order to downsize, and some clients are even retiring to “quieter” towns such as Armstrong, Comox, Cowichan, Courtenay, areas around 100 Mile House, and even Kaslo (wherever that is) as the population grows in the previous locations and cost of living begins to rise. This trend is likely to continue, and I would think even more so if Brian is right about this housing boom having legs.
In Canada lack of supply is a major culprit for the issues around housing affordability and cost of living. We, however, get to point our fingers squarely at our local governments for a good deal of that. One politician who has discussed this a number of times, and who’s videos I have grown rather fond of, is an MP from Ontario, Pierre Poilievre. Combining a speech he made in the house of commons and a virtual discussion he had with an expert on the issue, Pierre has pointed out that it is government red tape, more often than not, that prevents or delays the building of new homes and the benefits that construction would bring. He refers to the recent World Bank report where Canada ranks 36th out of 37 nations for the time it takes to receive a building permit. He refers to a Mr. Tim Brittle, a lumber mill owner in Ontario, who built a warehouse 40 years ago with one form, one engineer’s report, and a one week wait for approval. That warehouse is still standing today. He wanted to build another one of similar size and dimensions and had to wait 6 years, create 1500 pages of paperwork, and pay $600,000 in consultant and other fees before he could begin building. In Vancouver, according to Pierre, there are $600,000 in government costs to build multifamily housing and that number is $250,000 in Toronto… both egregious. Ironically, the municipal governments that prevent the building permits being issued and thereby drive up the cost of housing are the same governments that petition the federal taxpayer for more dollars for affordable housing. According to the expert he spoke with, the answer is a system where local input has a stake but cannot prevent or restrict development entirely and we get government out of the way.
You really should listen to Pierre, he says it so much better than I can, but I do have my own anecdotal story regarding permitting nonsense. I have a very good friend who also happens to be a mediocre realtor (and a regular reader of these emails, hopefully this one). He also is very familiar with development and works with a number of developers professionally. In 2018 the city of Vancouver gave the ok for townhomes to be built on most single family zoned lots. One of his clients purchased a $4 million lot and planned to build six townhomes on it, each with three bedrooms to service young families. They purchased said lot in Sept 2018 and just received the permit to build two weeks ago. Along with that permit came a requirement that they upgrade power to the entire block, a cost of $500,000. After another 18 months to build this client will have invested approximately $10 million over 4 years for a return of about 15% total, or 3.75% per year. And that is in an extremely hot housing market. The client was quoted as saying that “this is the first and the last time I will be doing this”. No wonder there is no housing supply in Vancouver. Who has the money and is willing to take the risk and suffer the waiting and the headaches for almost no return. Many of my friend’s developer clients are now looking outside Vancouver, in cities who are easier to deal with.
The issue is even rampant on high end homes. Another story from my same friend has a client wanting to change the windows on the front of a house they are renovating. The windows they want are a standard size and within code, but the city wants a full building permit to make that change (8-10 month wait) rather than a renovation permit (3-4 month wait). The building permit also means the owner will be required to install a sprinkler system on the high end home, a cost of $80,000. If you have ever wondered why homes are torn down rather than renovated, this is why. The permitting and costs to renovate are so extreme that it makes more sense to just build new, thus creating a $6M new home rather than a $4M renovated one. While you may not consider $4 million or $6 million “affordable”, that point is that even in high end real estate the problem is the same. Red tape is killing any chance for affordability no matter how you define it.
So while the housing market has certainly been crazy, perhaps it’s not as overheated as some may suggest. Banks, including RBC, have written thought pieces urging the government and regulators to make changes to cool the market and some of those are in the works, but they deal with the demand side of the equation…the ability for people to buy the homes. If nothing is done to fix the supply side as well it is possible we end up with a housing market that has cooled off because no one can afford the few homes that are available, rather than the better outcome of having enough supply of homes available at different price points for those looking for them.
As with most things, I think the answer lies somewhere in the middle. Certainly we need to cut some of the red tape that prevents and delays housing being built. We also likely need to make sure that people qualifying for purchases truly can afford those homes, even at higher rates, lest we repeat the sins of the Great Financial Crisis. As one of the more desirable cities in the world housing in Vancouver will always be expensive relative to any benchmark. Same goes for San Francisco, New York, LA, etc. There is a reason for it, and that reason is demand. Someone making minimum wage is likely never going to be able to afford a home in those cities easily, but there are other benefits to living there that may outweigh that fact (jobs, services, opportunity, infrastructure, community etc.). If not, then those people move…to the suburbs or to other towns or cities…as their personal situations and priorities change, and that diaspora helps invigorate the broader economy and is a free market control for housing prices. Fewer people in the city means less demand, which means lower prices. There should be affordable options for those unable to move, but those options may not include ownership in some cities. That said, those people should not be squeezed out of the market due to lack of supply or have rents driven up to unaffordable levels because the owners of those rental units have to pay so much to acquire them in the first place. A major city requires people from all walks of life, and so one without affordable housing options won’t remain much of a city for long.
More housing supply seems to be a reasonable answer to this discussion, no matter which side you take. Unfortunately with the red tape in place currently, it doesn’t seem likely that more supply will arrive in the near term, at least not in the volume required. If that is the case, then Mr. Wesbury may be right and easy money along with constrained housing supply will allow the boom to continue. Then again, maybe he’s wrong. Time will tell.
No matter which side you take on housing prices, maybe we can all agree on one thing. The fastest growing industry in Canada may be the bureaucracy, lobbyists, politicians and agencies who don’t make a living by creating anything, but instead by stopping progress and charging tolls and fees which discourage it. Oversight is important, we don’t want orphanages and elementary schools built next to nuclear power plants and munitions depots, but excessive red tape chokes the economy, and all of us along with it. As Jeff Bezos said in his farewell letter as CEO of Amazon “If you want to be successful in business (in life, actually), you have to create more than you consume”. That is certainly true in the housing market.
Have a great weekend everybody!