Mortgage Rules Changing and Timing

News abounds of the impending changes to maximum amortization lengths for government-underwritten mortgage insurance. This announcement follows the general form of previous announcements affecting CMHC, "strengthening" the housing market, and comments by Minister of Finance Jim Flaherty on concerns particularly about overbuilding in Toronto.

What's different this time is the implementation period is, in business terms, immediate: only 13 days to complete a transaction and fill out an application for mortgage insurance under the old guidelines. This was in an effort to avoid the surge in activity witnessed last year when the rules were changed with 60 day notice. To recap the changes to all mortgages that are eligible for government-underwritten mortgage insurance are as follows:

• Maximum amortization falls from 30 years to 25 years
• Lower the maximum amount Canadians can borrow when refinancing to 80 per cent from 85 per cent of the value of their homes
• Fix the maximum gross debt service ratio at 39 per cent and the maximum total debt service ratio at 44 per cent
• Limit the availability of government-backed insured mortgages to homes with a purchase price of less than $1 million.

Certainly none of these moves can be considered stimulative for housing, and in total impact it's around 10% less total debt that can be withdrawn based on the 30-25 year move, even more for top-prime borrowers, and completely snuffed for loans above $1MM, though it's unclear how many loans are insured above this level. There has been some good commentary on the moves and the implications in the short term.

What I wanted to concentrate on are two things, first the implications at the high end of the market in the event of a significant bout of weakness, (houses in higher-end areas of Vancouver are seeing months of inventory well above 10, which all but guarantees subsequent price drops) second the timing of the announcement.

1) If prices do become weak, many borrowers will find their equity has been compromised and banks, due to upcoming guideline changes to how it must account for mortgages, will be loath to carry these loans and require mortgage insurance as a hedge. If the property is valued above $1MM that leaves fewer options for the borrower and rates will increase, in some cases significantly. It's hard to tell by how much, but if current weakness extends through the remainder of the year -- which is no sure thing -- the high end of the market will suffer from another solid blow to the midsection.

2) The timing of this announcement caught me off-guard. It was issued subsequent to the G20 meeting in Mexico and at a time where rumours of a renewed bout of stimuli and recapitalizations occurring in the Eurozone, the United States, and China. My guess is that discussions regarding coordinated and large stimulus efforts were discussed at this meeting, ahead of the EU summit occurring this weekend. If a renewed bout of stimulus is put forward, this can flow, and in the past has flowed, into speculative assets, further deteriorating earnings ratios. The changes to CMHC's rules, designed to dam against further increasing household debt, by themselves could destroy a housing market in the face of slowing jobs and wage growth in the normally slower second half of the year for housing transactions. But if paired with a significant global stimulus, the effects may be muted.

(It may also be that this was the last opportunity for the Department of Finance to shoot off a policy directive before the vacation season kicks off, so the timing may be one of practicality more than any global machinations.)

The changes directed at the high-end and high-quality borrowers are interesting in the context of a potential renewed bout of global stimulus coupled with what looks like an unsustainable investment boom in other parts of the world, particularly China. Given the Bank of Canada has hinted in the past about the relatively high level of foreign investment in Canada's property markets, I wouldn't be surprised if they are attempting to both divert capital inflows and ensure another foray of borrowing by Canadian residents is impossible.

BC Population Growth to Q1 2012

BC Stats released its quarterly population estimates and BC continues sluggish growth through Q1 2012.

Population growth consists of the following bulk components:

• Natural increase (births - deaths)
• Net interprovincial migration
• Net international migration (including permanent and non-permanent residents)

So let's look at how recent quarters look in a historical context (there is seasonality so quarters are best compared to each other):

The most recent Q1-2012 data indicate continued negative net interprovincial migration (over 2400 net out of the province), though net international migration was more robust than 2011.

Below are graphs of NPR migration and annual population growth up to 2011. The drop off in 2010 is most likely due to changes in federal worker visa requirements, a one-time change. 2011 saw renewed NPR in-migration and gives some guidance as to what types of dwellings will need to be available to house such residents.

Weak population growth has continued through the first quarter of 2012, due in most part to migration to other provinces. These recent population data are what I would characterise as a continuing bearish indicator for BC real estate, especially for owner-occupier dwelling formation in the coming year.

Mortgage Renewal Gap June 2012

Below are some updated charts highlighting the so-called "renewal gap", the difference in mortgage rates a borrower will see upon renewal at certain terms. For example a borrower refinancing today who was in a 5 year term will see about a 2% reduction in interest rates. First the mortgage rates, second the "gap":

The renewal gap is projected assuming rates remain flat at current levels for the next 18 months. As can be seen, the majority of renewals with a negative gap from the past few years have taken place, with the exception of the 5 year which, barring any increase in rates, would see a negative renewal gap for the remainder of 2013. The tightening of the 3 year renewal gap can go some way to explain slower real estate activity in 2012. This graph should also be a reminder that lower rates for a prolonged period acts as a multi-year stimulus as households continue to reduce their carrying costs, all else equal.

Vancouver Rental Market Update April 2012

An important component of the housing market is the available rental stock. If inadequate housing is being built we should expect low vacancy rates and increasing rents. CMHC released its survey on monthly rents and vacancy rates for BC.

The CMHC report attempts to break down rents and vacancies based on region and on dwelling type, namely apartments, townhouses, detached dwellings, etc. based on number of bedrooms. Larger dwellings typically have higher vacancy rates than smaller ones and professionally-managed dwellings typically have lower vacancy rates than "amateur" dwellings.

Here are the numbers for "private apartments" (I'll update this as I fish out more data):

Vacancy rate

April 2010 2.2%

April 2011 2.8%
April 2012 2.6%

Availability rate (The availability rate measures the number of rental units which are vacant or for which the tenant has given or received notice to move and a new tenant has not yet signed a lease compared to the universe of rental units.)

April 2010 3.1%

April 2011 3.7%
April 2012 3.7%

Rents (CAD)

April 2010 978

April 2011 989
April 2012 1013

Change in rent

Apr-09-Apr-10 2.3%

Apr-10-Apr-11 1.6%
Apr-11-Apr-12 2.9%

Consider these readings as the "core" rental market. CMHC has in the past attempted to measure non-core rentals, such as houses, basement suites, and privately-held condo units rented out directly by owners or through smaller property management companies.

Vancouver usually has lower vacancy rates than outlying areas. When looking at cap rates for apartments, an area with lower vacancy rates will carry a lower cap rate. Rents were generally strong over the past year though vacancy rates have not statistically decreased. Increases in rent have generally kept up with wage growth. The allowable rent increase in BC for 2011 was 2.3%; this year it's 4.3%. It is plausible that last year saw the rental market demanding changes exceeding the allowable rent increase. How can the 2.9% increase seen last year exceed the rental limit? There are two major reasons: first, the survey includes some rent increases starting early in 2012 which can be at the 4.3% rate, and second, when a unit has tenant turnover, landlords have prerogative to increase rents to whatever they see fit.

Overall this is a solid report for rental growth, something in my view necessary to bring property valuations back down to earth.

Greater Vancouver Market Snapshot May 2012

Below are updated sales, inventory and months of inventory graphs for Greater Vancouver to May 2012.

Commentary:

May continued with relative weakness compared to not only 2011 but also past years from 2005 (except the residual emerging from the recession of 2008-2009). May sales are the lowest since the early part of the turn of the century.

This May was another weak report. This level of sales, if they continue to be weak, is going to translate into higher months of inventory for the rest of the year (MOI is typically higher in the latter half of the year; an MOI of around 6 normally translates to flat prices) and, likely, concomitant price drops. Prices (as measured by the Teranet HPI) will likely be year-on-year negative by the end of the summer.

As I mentioned last month, there are some worrying clouds on the horizon: population growth is falling, dwelling completions are set to increase in the latter half of the year, banks are beginning to implement stricter mortgage guidelines (though likely not in significant force until 2013), China's economy has slowed down, and the home ownership rate is highest in recent memory. On the other hand mortgage rates remain low, near net zero real territory, and it is possible for rates to remain low for a prolonged period (i.e. years). It is possible that Asian economies are due for another round of investment spending and that could lead to a renewed bout of current account flows into property. (This does NOT mean that investment by foreigners is prevalent.)

An interesting conjecture is that relatively little has changed from 2010-2011 for most of the Vancouver region (just look at prices outside of the marquee areas) with one notable exception: population growth is down. I am bearish on Vancouver housing prices based on their lacklustre earnings. Taking this view, if you believe my base arguments outlined in previous posts, it is now a matter of predicting the timing and rate by which prices will drop. Extending this, it looks like the first catalyst towards lower prices will be lower population growth.