Wednesday, December 03, 2014

An In-depth Look at the Canadian Housing Market

by Tom Bradley, Steadyhand Investment Funds
In the last couple of weeks, there has been two excellent reports published on the Canadian housing market – one by the Canada Mortgage and Housing Corporation (CMHC) and the other by RBC Global Asset Management. Both are good reads for people who want to dig into the detail and get a better understanding of the many factors that drive housing prices and activity.
Both reports draw conclusions that are consistent with what the real estate industry and banks are saying – there are some signs of strain in the market, but the risks are more benign than what the doomsayers like me are suggesting.
CMHC’s fourth quarter assessment provides an overview of where we are today (price trends, sales to listings ratios, unabsorbed inventory levels and vacancy rates on rental units). Overall, the report concludes that the Canadian market is not overbuilt and overheated, and only moderately overpriced.
Despite the conclusion, I find the CMHC report less useful in addressing what lies ahead. It uses some sophisticated modeling to measure current valuation, but the interest rate cycle is not discussed. Given that house prices are highly geared to changes in interest rates, some sensitivity analysis would have been useful.
The RBC report is very thorough and attempts to address all of the doomsayers’ concerns. There are many interesting charts, including the scorecard below:

I find the author’s conclusion (Chief Economist Eric Lascelles) to be surprising in light of this scorecard. He says, “Broadly, the near-term outlook appears benign, tilting only slightly in a negative direction.” Yes, the near-term is holding up OK, but there’s nothing benign about his 1-5 year outlook.
I learned a lot from both reports, but they didn’t change my view. There are a number of factors that weren’t discussed or need more emphasis:
  • House prices hinge on mortgage rates that are, by any measure, well below normal levels. Basing the price of an asset on another asset that is overpriced (bonds) is a scary proposition.
  • Pricing and market psychology will not be determined by the 72% of homeowners who have more than 25% equity in their house. Rather, it will be driven by the 5% who have less than 10% equity. The mistake forecasters made in the U.S. a decade ago was taking comfort from the majority instead of being wary of the weak minority.
  • What is bothersome is the number of factors that are in negative territory. It’s possible to explain away one or two ratios that are off trend (which Eric does well), but when there’s a wall of them, it gets to be a stretch.
  • Even the most positive of analysts have trouble pointing to any factors that are highly positive. The best either report can do is ‘neutral’. In my mind, it’s hard to make a case for investment when there are no positive indicators to offset the risks.
  • There’s little recognition in either report of how good the environment has been. These are not normal times. Housing prices have had a howling tailwind at their back – subsidized mortgage rates, abundant credit, a growth spurt in the buying cohort (25-34 year olds), rising home ownership and foreign buying. In a few years, we’ll look back and marvel at how good everything was.
  • And the one I feel most confident about – extreme cycles don’t end with ‘benign’ corrections. It just doesn’t happen.

Copyright © Steadyhand Investment Funds

Tuesday, November 18, 2014

Annual State of the Residential Mortgage Market in Canada - CAAMP

Annual State of the Residential Mortgage Market in Canada

Significant Statistics – November 2014
  • During 2014, 31% of Canadians obtained their mortgage from a mortgage broker, 61% directly from a bank.
  • For mortgage holders who renewed their mortgage in the last 12 months, 78% saw a reduction in their rate.
  • Mortgage discounting remains prevalent across Canada, for a 5-year fixed mortgage the average discount was 1.85%.
  • 69% of all outstanding mortgages are fixed rate, 24% variable and 6% combination. For the past 12 months 76% are fixed rate.
  • In the past year, 38% of mortgage holders either increased their amount of payment, made a lump sum payment or increased their frequency of payments.
  • 85% of all homeowners in Canada have 25% or more equity in their homes.
  • Mortgage credit growth will continue to slow, averaging 4.5% by end of 2015. Mortgage credit growth has averaged 8.1% per year during the past decade.
  • 70% of homeowners see their home as a place to live, 30% see it as an investment.
  • 11% of all homeowners took out equity from their property last year with an average take-out amount of $58,000. Debt consolidation and renovation are the top two areas where money was used.
  • The average mortgage interest rate in Canada is 3.24%.
  • Among homeowners who purchased during 2014, the average mortgage interest rate is 2.89%.

Friday, August 01, 2014

Canadian Real Estate - A Crack in the Tree

by Tom Bradley, Steadyhand Investment Funds

The Full Article

“It’s like if the tree in the backyard has a crack in it, you worry it’s vulnerable to a storm. But if no storm happens, it goes on and on, and maybe eventually strengthens through growth. If the right storm comes along and knocks it onto your neighbour’s house you’ve got a problem.”

This analogy for the Canadian residential real estate market is from our Bank Governor, Stephen Poloz. It prompted me to pull together a number of observations that were building up in my real estate file. In the attached piece (it’s too long for a blog), I point out that:
  • Being too early is tantamount to being wrong.
  • Real estate is a cyclical asset, cycles have a symmetry to them and therefore, extremely good cycles don’t end with a little pause or modest slowdown.
  • There’s a strong consensus that interest rates will stay low and house prices will stay high.
  • Fundamental measures are on balance negative. The most important ones are extremely negative.
  • Foreign buying, inter-generational transfer and the loonie are wild cards in the analysis.
  • Canadians are focused on the ‘Income Statement’ impact of buying a home (i.e. carrying cost), but are overlooking the ‘balance sheet’ impact.
  • We’ve been in an ideal environment for rising real estate prices. It’s been a ‘virtuous circle’. If a few of the variables turn, a downward spiral is equally possible.
  • A few other items that will make real estate bulls mad.
In true Steadyhand fashion, I’m not suggesting you make a big asset shift by selling your home and moving the family into a rental. But I am suggesting that it’s time for added caution. If possible, you should to be subtracting from this asset class, not adding.

Copyright © Steadyhand Investment Funds