Monday, July 30, 2012

Teranet HPI June 2012

Teranet Monthly Report - JULY 2012


Monthly changes in the Teranet-National Bank National Composite House Price Index tend to be greater in May and June of each year. The readings for May and June 2012 bear out this tendency, showing monthly gains of 1.1% and 1.2% respectively. The June increase takes the index to a new high for the third month in a row. June was also the second consecutive month in which none of the 11 metropolitan markets surveyed showed a price decline from the month before. The monthly rise was 1.7% in Calgary and Ottawa-Gatineau, 1.6% in Toronto, 1.5% in Winnipeg, 1.4% in Quebec City, 1.3% in Edmonton, 1.1% in Montreal, 0.9% in Halifax, 0.7% in Victoria and Hamilton and 0.5% in Vancouver. For the two Alberta markets it was the third consecutive strong monthly gain after seven months of decline. For Halifax it was the eighth straight monthly gain, the longest such run among the 11 markets. For Toronto and Montreal it was the sixth consecutive monthly gain. The index is now at an all-time high in eight of the 11 markets surveyed, the exceptions being Victoria, Calgary and Edmonton.
Teranet – National Bank National Composite House Price Index™

Since monthly changes are subject to seasonal factors, the 12-month change is revealing. In June the composite index was up 5.4% from a year earlier, a seventh consecutive month of deceleration in 12-month inflation. Since prices rose 1.4% from June to July last year, further deceleration is possible in July 2012. However, the only market in which 12-month inflation has followed the national composite in decelerating for seven straight months is Vancouver. Only two of the 11 markets show 12-month inflation exceeding the national average: Toronto, 9.5%, and Winnipeg, 7.8%. In Hamilton prices were up 5.4% from a year earlier, in Halifax 4.7%, in Montreal 4.4%, in Ottawa-Gatineau 4.0%, in Calgary 3.4%, in Quebec City 3.2%, in Vancouver 3.1% and in Edmonton 2.8%. Prices In Victoria were down 2.0% from a year earlier.

Metropolitan area Index level

June % change m/m % change y/y

Calgary 160.36 1.7 % 3.4 %

Edmonton 166.78 1.3 % 2.8 %

Halifax 140.73 0.9 % 4.8 %

Hamilton 133.69 0.7 % 5.4 %

Montreal 149.66 1.1 % 4.4 %

Ottawa 141.14 1.7 % 4.0 %

Quebec 169.71 1.4 % 3.2 %

Toronto 145.03 1.6 % 9.5 %

Vancouver 173.33 0.5 % 3.1 %

Victoria 140.40 0.7 % -2.0 %

Winnipeg 187.84 1.5 % 7.8 %

National Composite 6 153.58 1.3 % 5.9 %

National Composite 11 154.21 1.2 % 5.4 %
The Teranet–National Bank House Price Index™ is estimated by tracking observed or registered home prices over time using data collected from public land registries. All dwellings that have been sold at least twice are considered in the calculation of the index. This is known as the repeat sales method; a complete description of the method is given at

The Teranet–National Bank House Price Index™ is an independently developed representation of average home price changes in six metropolitan areas: Ottawa, Toronto, Calgary, Vancouver, Montreal and Halifax. The national composite index is the weighted average of the six metropolitan areas. The weights are based on aggregate value of dwellings as retrieved from the 2006 Statistics Canada Census. According to that census1, the aggregate value of occupied dwellings in the metropolitan areas covered by the indices was $1.168 trillion, or 53% of the Canadian aggregate value of $2.207 trillion.

All indices have a base value of 100 in June 2005. For example, an index value of 130 means that home prices have increased 30% since June 2005.

Marc Pinsonneault

Senior Economist

Economy & Strategy Group

National Bank of Canada

Teranet - National Bank House Price Index™ thanks the author for their special collaboration on this report.

Wednesday, July 11, 2012

Financing Advantages

Something that goes somewhat unstated in the real estate discussions I read online and in print is how, in Canada, residential financing receives preferential rates over similar investments not only for owner-occupiers (aka "homeowners") but also investors ranging from the family renting out a basement suite to those who actively manage multiple properties and derive the lion's share of their income from these operations. The article that piqued my interest is one written by Martin Wolf last year:

According to a FT article last week, Lloyds’ bank has a target return on equity of 14.5 per cent. Banks like to argue that this is the level of return on equity they need to earn, in order to gain funding from the markets. Naturally, remuneration is linked to achieving such objectives. The question, however, is whether such objectives make any sense. The brief answer is: no. 
Forget banks, for the moment. What would you say if someone offered you an investment with a promised real return of close to 15 per cent? You might say: “How much can I buy?” Alternatively, you might say: “What is the catch?” Sensible people must take the latter view. If you thought that you were being offered a reliable real return at such an exalted level, you would buy as much as you could. This must be particularly true now when real returns on the bonds of relatively safe governments are close to zero. 
So what is the catch? The obvious answer has to be that the real return in question is extremely risky, because it is volatile and offers a significant chance of total wipe-out.

So yes on the surface when someone claims a double-digit return on equity on an asset that ostensibly grows at the same rate as the overall economy one must think a bit, but Wolf makes a few observations about how this can be sustainable over long periods (emphasis mine):

In truth, there are two other reasons why banks might earn 15 per cent returns on equity, apart from the fact that these highly leveraged balance sheets are risky. One is that they can earn monopoly profits. The other is that they are subsidised, principally because taxpayers provide insurance against catastrophic risk, particularly for bank creditors. The two – monopoly and subsidy – are, of course, related. Without barriers to entry, subsidies would be arbitraged away. 
In short, when banks tell us that 15 per cent (or something in that neighbourhood) is their target returns on equity, they are saying that their businesses are very risky and/or protected against competition and/or well subsidised and probably a bit of all three.

In the case of housing in Canada, both investors and owner-occupiers have access to government-underwritten financing that pushes spreads down to levels that, without a government backstop, would be higher. In terms of the added spread, I've heard estimates of the added spreads of around 100bps for prime low-ratio loans. In cases where land is leased, liability is limited, LTV ratios are high, or cash flows are risky, this spread increases.

Canada has, for a prolonged period, subsidized residential investment and home ownership through preferential lending rates. If this produces net beneficial externalities the lower spread is somewhat justified but on the other side, as Wolf highlights in his post, government subsidy is not necessarily a free lunch; rather risks can build and must eventually be borne on government balance sheets, taxing future growth.

Canada has been riding increasing real land prices for over a generation and we should be cognizant of the risk that preferential financing is incurring a large and looming liability on the government's books. With the recent run up in prices nation-wide, with prices becoming detached from their utility and consumer debt loads increasing, it is worth pondering whether that reduced spread from free market has to be given back, in whole or in part. Given recent moves by the Bank of Canada and the federal government, it appears this line of thinking is under active consideration.

Wednesday, July 04, 2012

Greater Vancouver Market Snapshot June 2012

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


June 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). June sales are the lowest since the early part of the turn of the century.

This June was another weak report, and I have been stating this for the entire year. Sales year-to-date are bad and this has direct effects on incomes of those who depend on resale turnover for income. 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 concomitant price drops already starting to rear their heads in the posted MLS benchmark prices and medians. Prices (as measured by the Teranet HPI) will likely be year-on-year negative by the end of the summer.

As a consistent reminder, 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, and banks are beginning to implement stricter mortgage guidelines to be implemented first next Monday in the form of changes to government-underwritten mortgage insurance qualification criteria and second, to commence over the coming quarters, via implementation of stricter mortgage lending guidelines under OSFI's new directives. Further stress in current conditions can be attributed to China's slowing economic growth. 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 through coordinated government stimulus measures -- not only in Asia but also in other jurisdictions -- and that can plausibly lead to a renewed bout of current account flows into Vancouver-area property investments.

That we are comparing sales levels to those seen 10 years ago should be little surprise, in my view. I'm probably beating a dead horse here, but slower population growth does, and must, lead to lower sales and higher for-sale inventory. In the past inventory has been relatively poor at reacting to the cyclical nature of population growth in an capital-investment-heavy economy such as BC's. There is strong evidence that as an increase in residential building activity gathers pace, population growth increases are caused by this higher level of activity. In the wake of this activity completing, however, population growth drops. We are now seeing population growth drop. It is unclear how far this growth will fall -- spare capacity differentials in other parts of the country typically act as migration sinks and right now only the prairie provinces can claim this. Alberta, due to its proximity to BC, is the predominant source of interprovincial migration. Growth in manufacturing in Ontario -- BC's second-ranked migration source -- has been sluggish and the province is facing some overcapacity in the construction industry as well. In the next few quarters there looks to be little impetus to cause significant migration between Ontario and BC as was the case in decades previous.

Given the different dynamics of the Canadian economy compared to previous decades, I do not expect population growth to fall as drastically as was the case in the early-2000s. Nonetheless, given high house prices, I do not expect a marked rebound in population growth or interprovincial in-migration in the coming years. If this scenario were to manifest itself, that would translate to medium-term population growth approximately 20,000 below the longer-term trend, which translates to a decrease of about 8,000 dwellings formed annualised. In terms of direct impact on GDP that would be on the order of $2BB less activity, or 1% of BC's total.

Does that mean that population growth is the cause of price weakness? Not really; in this blog's view prices are detached from rents and incomes and these measures have been shown in other jurisdictions to be strong indicators of long-term price trends; changes in population growth, absent any exogenous shock, should then be viewed as nothing more than the inevitable means by which prices correct.

As a final aside, it cannot be stressed enough that there are severe risks to a significant recession in BC due to weakness in housing activity and lower prices. This has been well documented in other jurisdictions that have seen increased prices in short periods of time, as measured by price-income and price-rent ratios, and have inevitably experienced significant economic weakness when prices fall. While many may think Vancouver is certain of experiencing this fate, I nonetheless, mostly for posterity, take the view that such events are probable but not certain. Indeed for those who think a crash of the magnitudes implied by a reversion of price-rent ratios are inconceivable or improbable to the point of being assumed zero, I think that borders on negligence. It is incorrect to think that we can assign a zero probability to such an event occurring; if this blog's thesis is correct it will have turned out the probability of a crash was always high and not a so-called "nobody could have seen this coming" moment.

If the inconceivable does occur and prices fall substantially Vancouver has two paths it can take: refuse introspection and blame exogenous factors for its ills, or understand its inherent and chronic propensity for land speculation is a net impediment to its long-term economic growth. I am not optimistic the latter will be the view held in popular discourse.

Anyways, there you have it. Another weak report for resale housing activity in the Vancouver area.