Wednesday, July 21, 2010

Bank of Canada Paper on Housing Stock

TitleA Model of Housing Stock for Canada
AuthorDavid Dupuis and Yi Zheng
TypeWorking Paper 2010-19
Date of
publication
July 2010
LanguageEnglish
AbstractUsing an error-correction model (ECM) framework, the authors attempt to quantify the degree of disequilibrium in Canadian housing stock over the period 1961–2008 for the national aggregate and over 1981–2008 for the provinces. They find that, based on quarterly data, the level of housing stock in the long run is associated with population, real per capita disposable income, and real house prices. Population growth (net migration, particularly for the western provinces) is also an important determinant of the short-run dynamics of housing stock, after controlling for serial correlation in the dependent variable. Real mortgage rates, consumer confidence, and a number of other variables identified in the literature are found to play a small role in the short run. The authors’ model suggests that the Canadian housing stock was 2 per cent above its equilibrium level at the end of 2008. There was likely overbuilding, to varying degrees, in Saskatchewan, New Brunswick, British Columbia, Ontario, and Quebec.
Bank
topic index
Domestic demand and components
JEL
classification
E21, J00

You may download the paper in the following format(s):

22 comments:

jesse said...

A search for the word "rent" in their paper yielded only 1 hit, in reference to CPI.

Maybe it's too obvious for the authors but fluctuations in rents vis a vis incomes should be a very good proxy for relating total population to housing supply.

承蘋承蘋 said...

感動 + 感恩 + 感謝(。-ˍ-。 )............................................................

JimTan said...

I wonder what this means,

"In the spirit of McCarthy and Peach (2002, 2004), Demers (2005) estimates a system of
equations that models Canadian housing investment (new and resale) and housing prices
for the period 1961–2004. Empirical results show that fundamental variables (wealth,
mortgage rates, and demographics) help explain variations in housing investment, both in
the long and the short run. However, a valid long-run relationship that links the relative
price of housing to fundamentals could not be found.

Aside from Demers (2005), there have been only a limited number of recent studies in the
Canadian context, almost all of which are concerned with prices. In a relevant study using
an ECM framework, Allen et al. (2006) focus on the long-run relationship between resale
housing prices and a number of explanatory variables (new housing prices, union wage
rates, mortgage rates, GDP, building permits, and the labour force) at the individual city
level after failing to find evidence in support of cointegration between city housing prices
and an aggregate price for Canada over 1981–2005. In general, they find that only new
housing prices, union wage rates, and building permits explain resale housing price
movements in the long run."

JimTan said...

In addition, the lack of a supply-side equation in the model introduces the risk that an important piece in the
fundamentals of the housing market will be missed. This issue is more important for urban centres, where the assumption of elastic supply may not hold. Research has shown that the length and magnitude of a housing bubble could be related to the elasticity of supply. Future research should therefore take more of a systems approach if more reliable supply-side data become available.

vibe said...

Jim, what exactly are you wondering about? The authors are summarizing their literature review and are pointing out some of the shortcomings of previous works.

The important take away is that the current level of housing stock is not supported by demand. Mohican and others here have been saying as much for a while, and this paper supports that argument.

Regardless of what the supply side analysis would reveal, the point is that this paper suggests that current prices are not elevated due to a lack of housing stock.

JimTan said...

Here's my take on the matter at RET forum.

http://www.realestatetalks.com/viewtopic.php?f=8&t=39180&start=135

Tomas said...

Prices will go down: twitter.com/squidly77

JimTan said...

HeHe!

(Page 26) The impact of the employment rate and real mortgage rate is small overall and only significant in a few provinces. Using the participation rate, unemployment, and an affordability index instead does not improve the results. This suggests that the fluctuations in housing demand in the short run do not necessarily coincide with those in labour market conditions, and that the much-touted impact of falling mortgage rates on housing demand is secondary to more fundamental driving forces such as demographics.

陳璇竹陳璇竹 said...

文章不求沽名釣譽,率性就是真的..................................................................

JimTan said...

Okay! Let's look at the numbers for BC province (Table 11: Deviation of Housing Stock from Long-Run Equilibrium as of 2008Q4 for BC province). % Deviation in 2008 is 3.5%. Maximum deviation occurred in 2005 of 6.7% (Time series Figure 9).

Oddly enough, Vancouver's market didn't crash in 2005 and the over-investment declined! Compare with Saskatchewan's 44% max deviation in 2008. Will Saskatchewan crash? Why haven't they?

The authors pointed out that their price estimations of housing stock overstate housing inventory in terms of units. Therefore, their study is about over-INVESTMENT and not about over-building. Don't hold your breath waiting for a crash!

After adjusting for the bridge equation (renovations), Canada's and Vancouver's surplus doesn't look so serious. This conclusion would be in line with the current rental vacancy rates and the strong resale market.

The bears are seizing on the POSITIVE RELATIONSHIP BETWEEN HOUSING STOCK AND HOUSE PRICES as a sign of irrational investing. But, much of this is due to upgrading and renovation which adds value to the property.

Why would Vancouverites invest more than the average Canadian in renovations? Renovation is necessary because of depreciation. Older units need to be vigorously maintained to afford costly repairs. Leaky condo syndrome may play a part in it.

Moreover, people who purchase high-price property tend to upgrade the interior to a standard consistent with the price tier. The money isn't wasted. The upgrading adds to the value.

So, here's the big question. How did Vancouverites afford such expensive housing? Did they borrow up to their eyebrows? Are they in over their head.?

The answer is that on average Vancouver is in good financial shape. They saved more, and diverted more of their portfolio into RE instead of financial investments. As a result, Vancouverites were LESS INDEBTED than the national average.

Average household debt/ average household net worth = 28% Vancouver, 31% national average, Calgary 35%, Halifax 37%
Average household investments/ average household net worth = 32% Vancouver 36% national average Halifax 46% Calgary 48%

http://www.theglobeandmail.com/globe-investor/personal-finance/want-to-boost-your-net-worth-live-in-a-mid-sized-city/article1640442/

JimTan said...

Next, it is normal in portfolio management to rebalance your portfolio when one asset class gets too large. However, this is not usually possible for property owners when transaction costs are high and inventory/choice is limited.

Finally, can 'ordinary' people afford to buy Vancouver properties today. Is Vancouver sufficiently affordable?

The evidence points to the willingness of most Vancouverites to take risk and make sacrifices. It's part of the culture, and Joe and Jane have learned to play the game. It has paid off. The report from the CAAMP ( Certified Mortgage Professionals) indicate that the overwhelming majority of current buyers are borrowing cautiously.

What happens when the market temporarily reaches the limit of affordability? Then, the supply situation is critical. Prices don't collapse when excess inventory is small. That is, supply elasticity is limited.

Unlike tulips, people need to live in houses. Property owners don't sell when the alternatives are limited. Do they move to Toronto or Chilliwack? Do they sell their Vancouver West home and move to Abbotsford? Are there reasonable choices in rental property?

Renters can hold on until rental vacancies disappear. Then, it's the back to the game of Desperately Seeking Vacancies!

As the authors have pointed out, demand side drivers like demographics tend to be long term in nature. The key uncertainty lies in the supply side factors.

Why would supply be inelastic? As I have already pointed out in this 'Bubble' thread and elsewhere, northwest cities have made choices about liveability and lifestyle. There is tremendous resistance to densification and urban sprawl. Long term supply elasticity (like long term demographic trends) is small.

So, the inevitable consequence of inelastic supply and rising demand is large price increases in order to persuade landowners to sell. Vancouver is very expensive, and yet they keep coming.

In the short run, developers have shown tremendous discipline during a slump. They cut housing starts and sit on their land bank for years. The short-term elasticity of supply (when prices are weak) is another reason why Vancouverites have confidence in their RE investments.

As the authors pointed out. It's hard to see how irrational exuberance can persist for long periods of time. There must be fundamental factors at work.

vibe said...

Therefore, their study is about over-INVESTMENT and not about over-building.

Over-investment could be due to overbuilding or prices that are too high. Either way you should expect a correction.

They saved more, and diverted more of their portfolio into RE instead of financial investments. As a result, Vancouverites were LESS INDEBTED than the national average.

Vancouverites are more indebted than any other city except Calgary. Our net worth is the highest as well but this is at least partly due to overinflated house prices. I won't bother to point out the problems with using averages.

most Vancouverites...take risk and make sacrifices...the overwhelming majority of current buyers are borrowing cautiously.

Ok...

Prices don't collapse when excess inventory is small. That is, supply elasticity is limited.

Prices collapse when prices get too high. It seems that you have gone from arguing that a lack of supply will prevent prices from dropping to now saying that a small over supply won't cause prices to drop. How about just admitting that current prices are not justified on a fundamental basis.

There is tremendous resistance to densification and urban sprawl.

Is that a joke?

It's hard to see how irrational exuberance can persist for long periods of time. There must be fundamental factors at work.

Now I know that's a joke, thanks for the laugh.

jesse said...

So, the inevitable consequence of inelastic supply and rising demand is large price increases in order to persuade landowners to sell.

An inevitable consequence of inelastic supply is significant price fluctuations if demand abates. Low sales with low interest rates. Not looking good for landowners.

JimTan said...

"It's hard to see how irrational exuberance can persist for long periods of time. There must be fundamental factors at work.

Now I know that's a joke, thanks for the laugh."

Vive,

You explain it if you are so smart!!!!!!!

vibe said...

First off, you're begging the question. If you start with the premise that bubbles can't happen then your explanation will always be wrong if you are, in fact, in a bubble.

Now, would you not agree that what happened in the US housing market was a prolonged period of irrational exuberance? What about Japan? Nasdaq? How can you live through all of these bubbles and then claim that they don't happen?

My explanation: we're in a bubble, duh.

vibe said...

Here is the quote in context. I don't know that the authors are saying what you are implying.

The positive relationship between real housing prices and housing stock in Nova Scotia and British Columbia is puzzling. While, in the short run, speculation or irrational expectations of persistent housing price appreciation could lead to an increase in investment at the same time that prices are going up, such a phenomenon is harder to explain in the long run.

JimTan said...

Dear Vibe,

That's my point exactly.

I'm not saying that bubbles can't happen. Bubbles can happen in the short run because supply is inelastic. Demand exceeds supply and speculators chase the prices up for a quick buck.

But, in the longer run, supply catches up with demand and the bubble pops. We saw that in Calgary and the American cities. Like the authors, I believe that fundamental factors are at work if high prices are sustained in the long run.

So far, you have provided no evidence that a bubble exists. Why hasn't Canadian RE collapsed like the States? Why is Vancouver not like Miami?

vibe said...

1. Price to rent at all time highs
2. Price to income over 10
3. Real house prices at all time highs
4. Recent market volatility shows lack of fundamental support
5. Growth in housing stock not explained by population growth or other fundamentals
6. US bubble lasted just as long in many cities

If you can't spot a bubble until it pops then you are in a lot of danger my friend.

JimTan said...

Dear Vibe,

My friend! Ask Mohican to give you a lesson in statistical analysis.

For myself, I stand by my record. I was a bear in 2007. In late 2008, I argued with the bears that a depression was not in the cards. In early 2009, I was a bull. In late 2009, I argued against the bubble theory held by our bears.

The Olympics is ovr and no crash. There has been no meaningful correction in 2009 or 2010. So...

vibe said...

So...what? There was no crash in the US in 2004, 2005...

You are basically saying that calling a bubble before the crash is premature. Fine. If that is what you believe then so be it. I'm no statistician, that I will admit. But I don't think it takes one to figure out that you are talking out of your derriere. :)

JimTan said...

"You are basically saying that calling a bubble before the crash is premature. Fine. If that is what you believe then so be it. I'm no statistician, that I will admit."

Wrong!

I am saying that it is possible to tell the difference bewteen bubble and non-bubble conditions before a crash.

http://www.realestatetalks.com/viewtopic.php?f=8&t=39180&st=0&sk=t&sd=a&hilit=when+bubble+bubble

OK said...

Typical.