Interest Rates and 2014

The Canadian mortgage market favours five year fixed rate term renewals, and as such the prospects for those looking to renew mortgages in the coming year matters for inflation as well as credit growth. A borrower has a few options at renewal time, including continuing to amortize a loan on its original schedule, refinancing for a different loan amount, and changing between fixed and variable rate over various terms. Now-retired "Vancouver Housing Blogger" brought us the concept of the "renewal gap", the interest rate differential a borrower sees upon mortgage renewal, shown below for the 5 year fixed rate mortgage using the "average residential mortgage rate" as reported by CMHC, and the "posted" rate as reported by the Bank of Canada (note current rates are held as constant indefinitely into the future):

Extending this concept further, we can look in terms of change in payment, which depends upon whether a borrower refinances or re-amortizes. The four scenarios considered are:

• Borrower refinances a 5-year amortized $100,000 loan into another $100,000 25 year amortization loan (and pocketing the amortized amount) (blue line)
• Borrower refinances a 5-year amortized $100,000 loan into a $100,000 20 year amortization loan (and pocketing the amortized amount) (red line)
• Borrower continues a 5-year amortized $100,000 loan into a 25-year amortization loan (ie extends the amortization only) (yellow line)
• Borrower continues a 5-year amortized $100,000 loan into a 20-year amortization loan (ie continues the amortization schedule; this would be the scenario for a borrower who wants to continue with a government-insured policy loan) (green line)

The four scenarios are graphed below for the average lending rate, again assuming current rates are extended indefinitely into the future:

The blue and green lines overlap exactly. That is, a borrower deciding to refinance a $100,000 loan for 25 years or continuing to finance a loan five years into its 25 year amortization for 20 years is the same. If a borrower decides to refinance but not re-amortize, that results in a higher payment, and if a borrower decides not to refinance but to re-amortize, that results in the lowest payment in the scenarios considered.

Starting in 2012 and continuing all the way until today, all four scenarios resulted in lower mortgage payments compared to the previous five year term. Starting in early 2014, that scenario quickly changes, with only the re-amortization scenario offering any significant easing of payments. The sudden change in payment terms for borrowers will tend to reduce credit growth and yet be relatively inflationary through most of 2014 and all years hence, barring any significant drops in mortgage rates.

Canadian and US Bond Yields

The perpetual threat of rising bond yields that (one assumes) translate to higher mortgage rates are back in the news. Well, rising US yields are in the press, anyways, and we all know that Canadian yields are tightly linked to US bond yields.

The graph below shows the linear spread between Canadian and US 10 year bond yields (ie the Canadian 10Y bond yield minus the US 10Y bond yield) since 1955:

When we say Canadian and US yields track, it is in the statistical context.

Teranet House Price Index - Home Prices Down in November

HOME PRICES DOWN 0.1% IN NOVEMBER

In November the Teranet–National Bank National Composite House Price Index™ was down 0.1% from the month before, essentially reversing the October gain. Because prices in November 2012 had declined by a greater margin, 12-month home price inflation accelerated to 3.4% from 3.1% in October. The rise from a year earlier exceeded the cross-country average in five of the 11 metropolitan markets surveyed for the index: Calgary (5.9%), Hamilton (5.2%), Toronto (4.2%), Vancouver (3.9%) and Quebec City (3.7%). The 12-month gain lagged the average in Edmonton (3.0%), Winnipeg (2.8%), Ottawa-Gatineau (1.2%), Halifax and Montreal (0.8%). Prices were down from a year earlier for a ninth consecutive month in Victoria (−1.4%).

Teranet – National Bank National Composite House Price Index™

The 0.1% monthly decline of the composite index was the fourth November decline in a row. Be it as it may, since November prices have on average gained 0.1% from the month before over the 15 years of data index collection, this year’s retreat does not signal a buoying market. Prices were up on the month in four of the 11 metropolitan areas: Vancouver and Halifax (0.6%), Hamilton (0.3%) and Winnipeg (0.1%). The Winnipeg gain was the first in five months. Prices were down from the month before in Victoria (−1.8%), in Montreal (−0.6%), in Calgary (−0.3%) and in Edmonton, Quebec City, Ottawa-Gatineau and Toronto (−0.2%). Vancouver prices have been rising for seven straight months, reaching a new record in November. However, prices in six of the 11 markets have been trending down recently: for four consecutive months in Quebec City (total −1.8%), Montreal (−1.4%) and Edmonton (−1.1%); for three consecutive months in Ottawa-Gatineau (total −0.8%). Prices have declined 0.4% in Toronto over the last three months and 2.4% over the last two months in Victoria. Despite November’s increase, prices are down 0.7% over the last five months in Winnipeg.

Teranet – National Bank House Price Index™

The historical data of the Teranet–National Bank House Price Index™ is available at www.housepriceindex.ca.

Metropolitan area	Index level November	% change m/m	% change y/y
Calgary	172.23	-0.3 %	5.9 %
Edmonton	171.19	-0.2 %	3.0 %
Halifax	142.07	0.6 %	0.8 %
Hamilton	147.03	0.3 %	5.2 %
Montreal	149.65	-0.6 %	0.8 %
Ottawa	142.39	-0.2 %	1.2 %
Quebec	176.42	-0.2 %	3.7 %
Toronto	153.50	-0.2 %	4.2 %
Vancouver	174.04	0.6 %	3.9 %
Victoria	136.22	-1.8 %	-1.4 %
Winnipeg	193.82	0.1 %	2.8 %
National Composite 6	158.53	0.0 %	3.5 %
National Composite 11	159.21	-0.1 %	3.4 %

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 www.housepriceindex.ca.

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.

By :

Marc Pinsonneault Senior Economist Economy & Strategy Group National Bank of Canada

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

IMF says Ottawa should consider ending CMHC mortgage insurance

IMF says Ottawa should consider ending CMHC mortgage insurance

BC Employment October 2013

Below are some graphs highlighting Vancouver's and BC's employment situation. Here are the historical employment, participation, and unemployment rates (CANSIM tables 282-0117 and 282-0087) (click on chart for larger image)

American economics blogger Calculated Risk looks at employment from the point of view of participation rate for the 25-54 age cohorts and the so-called "employment to population ratio", the ratio of those employed to the population. Below is BC's participation rate and employment-population ratio for the 25-54 cohort:

Somewhat of a surprise was graphing Canada's participation rate and employment-population ratio compared to the US. Here I quickly overlaid Calculated Risk's US graph with the Canadian one, again for the 25-54 age cohort:

Since 2002 there has been a marked divergence in the countries' participation rates and a reversal of the countries' employment-population ratio differential.

Greater Vancouver Market Snapshot October 2013

Below are updated sales, inventory, months of inventory, and sell-newlist ratio graphs for Greater Vancouver to October 2013. (see REBGV news releases) (click on image to enlarge)

The scatterplot of 6 month price changes and months of inventory is below. The most recent datum is the brown dot at about (MOI=6.3,price_change=2%) . The trend is roughly in line with past years.

My estimates for October were for inventory of 15605 (actual 15257) and sales of 2657 (actual 2661) based on estimating average changes from September of years 2005-2012. Using the same technique estimates inventory and sales for November of 13968 and 2185 respectively (MOI=6.4).

September 2013 Residential Construction Activity - Vancouver CMA

Below are CMHC starts, completions and under construction for Vancouver CMA to September 2013. Starts and completions are displayed as 12 month sums:

The first graph below is completed but unabsorbed inventory for single and semi detached properties, the second graph is showing the sum of single and semi detached under construction and completed but unabsorbed, which provides a proxy for near-term inventory of new properties of that type. (Single and semi-detached typically have construction cycle of less than a year.)

By the unabsorbed plus under construction measure, single and semi detached inventory has been at a level unseen since the early 1990s since early 2013.

Vancouver CMA Price to Rent Ratio

A popular ratio used to measure relative housing valuations is the "price to rent ratio" that takes a benchmark price and divides by the annual or monthly rent. This forms a type of price-earnings ratio of housing from an investment perspective. There are some significant caveats with this measure, not least the data sources used. This post will outline the various sources of data and what I believe to be the best measure of a pure price-rent ratio as well as some of the factors and limitations that are inherent in the measure.

Prices

Prices are measured in various ways, from simple average or median prices (average can be found on realtylink.org website, the median can be found in various places, for example the Demographia survey). Royal LePage has data going back to the 1970s to the municipality level and attempt to adjust for sales mix. Other measures include the Teranet HPI that, like the US-focused Case-Shiller house price index, uses sales pairs to attempt to adjust for quality differences in the data. A more recent measure starting to be adopted across the country is the MLS-HPI that uses a form of hedonic adjustments to perform a quality adjustment on sales. Although not using the same methodology as the Teranet model, the MLS-HPI has broadly tracked the Teranet HPI.

The MLS-HPI, Royal Lepage, and average data are broken down by housing type, broadly single detached, townhome, and condo. Teranet provides only aggregated data publicly but does track data based on housing types.

Rents

Rents are more difficult to measure, mostly because the sources of the data are not collated anywhere save through CPI measures ("rented accommodation" and "owner equivalent rent") and some other surveys that have been performed over the years. Metro Vancouver and CMHC have attempted to measure rents through broad-reaching surveys and other datasets with some success. CMHC surveys rents from a pool of purpose-built rental units and has a dataset extending back to 1992. CPI data extend back further than this.

Comparing prices and rents

Price-rent ratio, at its core, is a measure of how favourable an investment housing is at current valuations. A higher price-rent ratio generally indicates a less favourable investment and a lower price-rent ratio indicates a more favourable investment. To understand what price-rent ratio is actually indicating involves more in-depth analysis than what is possible in a blog post. Nonetheless several broad factors can and do influence price-rent ratios being higher and lower. These factors include:

• Quality and age. A property that has a more stable income stream or requires less maintenance will generally have a higher price-rent ratio. For example a new condominium requiring little maintenance outlays and attracting high-quality dependable tenants will be a safer investment that requires less discounting. As a building ages it can become "dated" (resulting in less favourable rental terms for the landlord) or incur additional maintenance that will require cash outlays from the owner. As a unit ages its price-rent ratio will tend to fall.
• Financing. Both short-term financing (ie 5 years or less) and longer-term financing (say a 30 year mortgage) can influence price-rent ratio. Investors will pay higher prices if the financing costs are lower (like a bond), though the caveat is that, in Canada, financing needs to be periodically renewed and that investing in property has a fixed land component that never depreciates. This means that while financing costs can decrease due to lower interest rates, if rates go higher at any point in the future (not just over the course of the loan) this benefit is lost.
• Density. A low density property in an area undergoing rezoning or other density changes will factor in both current and future land use into its price. This means that, say, a 60 year old bungalow in a desirable higher-density area will have a high price-rent ratio. Over time, as the area continues to increase in density, the land becomes more valuable and the price-rent ratio will tend to increase over time. This means that many properties will carry a "ludicrous" price-rent ratio but that does not necessarily mean they are overvalued.
• Rents and income. An area can be undergoing gentrification or population growth that put pressures on rents or imputed rents. This means, ultimately, that the market expects rents to increase faster than inflation and this will push up future earnings from the property. This will lead to a higher price-rent ratio.
• Consumer surplus. If the marginal buyer is not solely focused on cash flows but on ownership this can cause prices to rise above what what an investor may be willing to pay. If owner-occupiers place an intangible net benefit on home ownership they will pay a premium relative to renting. This forces down yields for landlords, although they benefit from the capital appreciation.

There are other factors, such as raw speculation, that affect price-rent ratios. It is not immediately true that all factors that can plausibly affect price-rent ratios are unsustainable. From a net-present-value perspective there are many factors that are "value based" -- meaning future earnings from operations are reasonably expected to support a competitive inflation and risk-adjusted return -- and some that are "speculative" -- meaning future earnings are supported more by the future sales price and less by income. (My use of "value" and "speculative" should not connote good and bad, but should acknowledge how one makes one's money.)

Determining which measures to use

Determining which measures to use for the price-rent ratio involves correcting for sales mix but also correcting for other factors that can determine which factors are supported by incomes and those that are supported only by speculative activities. It can be difficult to separate certain premiums based on density increases from depreciation, finance, or rent-inflation-related factors.

Luckily, to help with this, we have a measure of quality adjustment in the form of the Teranet and MLS-HPIs that reduce the effect of depreciation and quality in our measure. In terms of density increases, this can be partly ameliorated by focusing on already-dense properties such as apartments that are unlikely to undergo significant density-increasing redevelopment in the foreseeable future. This leaves us with the residuals of rental inflation, financing, and of course the catch-all of speculation.

In terms of which rents to use, to compare a same investment over time, given we have a quality-adjusted measure of apartment prices, the best measure is to use a quality-adjusted measure of apartment rents. Here we are in luck because the CMHC rental survey measures purpose-built apartment rents over time. Since purpose-built apartment stock is generally not being replenished in any significant way (though that may change in the coming years), the rents measured on these units are de facto quality-adjusted.

So we have our chosen price and rent measures. Using the Greater Vancouver apartment MLS-HPI, dividing by the CMHC one bedroom apartment rent and normalizing (to 2005), we get the price-rent ratio that I often reference on this blog:

This measure shows the impact of rising rents on the ratio since its peak in 2008, and how elevated the ratio is compared to its value through the 1990s. This measure will be affected by the following broad factors:

• Market expectations of future rent appreciation
• Market expectations of future mortgage rates
• Speculation and other non-cash-flow-supporting returns

The measure broadly corrects for:

• Expected density increases
• Quality and age

The price-rent ratio graph above is by no means a definitive measure of valuation. It is a measure with imprecise factors and should be used as part of a larger suite of measures to form an argument for the sustainability of current housing valuations.

As to what is a "reasonable" price-rent ratio, well, that is the question, isn't it?

Greater Vancouver Market Snapshot September 2013

Below are updated sales, inventory and months of inventory graphs for Greater Vancouver to September 2013. (see REBGV news releases) (click on image to enlarge)

The scatterplot of 6 month price changes and months of inventory is below. The most recent datum is the brown dot at about (MOI=6.3,price_change=3%) . The trend is roughly in line with past years.

The other graph I have added is the price-rent ratio for a Greater Vancouver apartment, using REBGV apartment MLS-HPI and CMHC-reported rents (extrapolated, as they are only reported once per year), normalized to January 2005. By this measure, price-rent is currently 15% above its value in 2005 and 27-64% above the range of values from 1992-2004. 

A caveat about this graph is that it aggregates various price tiers and municipalities into one. If higher valued apartments have appreciated more than lower valued ones this would mean price-rent on the lower end is lower than this graph would indicate (and vice versa). Put another way, price data may have been skewed by higher-tier purchases appreciating faster than the lower-tier ones. Lower tier apartments may be more likely to be rented out, in which case from an investment perspective the price-rent ratio in the graph below may be on the high side.

My estimates for August were for inventory of 16663 (actual 16155) and sales of 2353 (actual 2483) based on estimating average changes from August of years 2005-2012. Using the same technique estimates inventory and sales for October of 15605 and 2657 respectively (MOI=5.9).

BC Population Growth to Q2 2013

BC Stats released its quarterly population estimates yesterday. Population growth consists of the following bulk components:

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

So let's look at how recent quarters look in a historical context, here graphed since 1961 to show longer-term trends (there is seasonality so quarters are best compared to each other, also do not integrate these graphs, the total population is periodically adjusted during census counts). 4 quarter rolling averages are shown.

Since 2008, net NPRs have been contributing a level of population growth approaching that of the natural increase. From datasets "Total entries of foreign workers by province or territory and urban area" and "Total entries of foreign students by province or territory and urban area", the following data on foreign worker student, and humanitarian components of NPR entries in BC:

2012 Temporary Foreign Workers (TFW), Student, and Humanitarian Entries in Vancouver and BC

	Vancouver	BC	% Vancouver of BC
TFW	19315	49511	39%
Student	14677	26647	55%
Humanitarian	394	1175	34%
Total In	34386	77333	44%
Total Out*	-	69491	-
Net	-	7842	-
% net of total in	-	10%	-

* estimate by subtracting Net from Total In.

The influx of NPRs to BC was around 77,000 in 2012, however the outflux was around 69,000. According to CANSIM 051-0020 there were 151,637 NPRs in BC as of January 1, 2013, which approximately aligns with integrating historical net NPRs from the population growth estimates. NPRs have comprised 19% of the province's total population growth since the beginning of 2008.

Passive Investing - The Evidence, Part 1: The Outperformance Myth (+play...

Vancouver CMA Population and Dwelling Distributions 2006 to 2011

Statscan released their 2011 National Housing Survey results earlier this week. I found a couple of datasets that are broadly comparable to the previous 2006 census data. Below are graphs looking at overall population growth and dwelling composition based on structural type (defined here). Here is a brief summary of some structural type definitions:

• single detached: one dwelling with no walls adjoining another structure
• apartment, duplex: detached housing with suites (for example)
• row house: dwellings in a group with shared walls
• apartment >= 5 stories: condo towers
• apratment < 5 stories: low to mid-rise condos

The first graph looks at the average household size by structural type with the change since 2006. Notice that "apartment, duplex" and apartments with >= 5 stories saw increasing household size. Row and single detached were unchanged, and low-rise apartments saw lower household size. Overall the household size was unchanged since 2006. (Click on image to enlarge.)

Next is looking at the distribution of dwelling growth based on structural type. On a per-dwelling basis apartments were the most significant contributor to dwelling formation however on a population growth basis the at-grade structures (single detached, apartment duplex, and row house) housed the majority of the region's population growth.

As to why this is, we can look at the distribution based on household size to see that while apartments contribute more on a per-dwelling basis their household sizes are smaller so will have a lower impact on population absorption on a per-unit basis. This is obvious but for posterity here are the distributions:

The most interesting thing for me is the stagnation of the household size number since 2006. A few other notes:

• 67% of the metro's population growth was absorbed in single detached, apartment duplex, and row housing.
• Households of 3 or more people made up 39% of dwelling formation but 62% of population growth.

Household size could be bottoming earlier than predicted. There are, however, some plausible reasons why household size has only temporarily plateaued instead of continuing a downwards trend since the 1970s:

• The 2006-2011 period encompassed a severe recession and slow recovery with elevated unemployment. This could cause an increase in household size, for example an unemployed worker moves in with parents, or a student decides to live at home instead of moving out of the family home.
• The NHS has collected on a voluntary basis so there may be errors that skew the 2011 data.
• Rents increased above inflation over the 2006-2011 period and that could cause some increase in household size.

On another interesting note, laneway houses are likely counted as "single detached" dwellings. There were about 200 such dwellings build in the City of Vancouver before the 2011 NHS. Assuming laneway starts average 40 per month for the next three years, this could add about 1800 additional "single detached" dwellings to the dwelling count for the 2016 NHS.

City of Vancouver Permit Data to July 2013

Below are data graphed from the City of Vancouver's Statistics on construction activity.

The following graphs are broken up by residential permits and value, by source: multi, single/duplex, and laneway. I have also graphed demolitions and alteration/repair/addition permits. (Click on images to enlarge.)

Below are construction permits based on value by source, first in absolute terms and second is the relative distribution:

Notes:

• Laneway housing permits have surpassed 1,000. July saw the largest number of laneway permits issued since the type's inception in 2009, at 75.
• There were no multi-unit construction permits recorded in July. This may be an error.
• Total permit value to date is $1.20 Billion, which is down from $1.47 Billion this time last year.

BC Employment August 2013

Below are some graphs highlighting Vancouver's and BC's employment situation. Here are the historical employment, participation, and unemployment rates (CANSIM tables 282-0117 and 282-0087) (click on chart for larger image)

Below are three interesting plots, first BC population growth, residential units under construction, and the construction unemployment rate, followed by a scatterplot of the construction unemployment rate versus residential units under construction (on semilog):

Not surprisingly when units under construction are low, construction unemployment is elevated and vice versa. Also interesting is that high construction unemployment is partially ameliorated by labour mobility (captured by falling population growth).

The final graph is more scattered but nonetheless interesting. A few years ago BC Stats highlighted that unemployment differentials between provinces, most notably between BC and Alberta, leads to increased labour mobility. The plot below is between population growth and the BC-Alberta unemployment rate differential (spread). Current BC-AB unemployment differentials have been approximately 2.0% since the beginning of 2011, and current population growth is approximately 40,000/year. Net migration to Alberta (ie people leaving BC for Alberta minus people leaving Alberta for BC) is currently about 11,000 people annualized.

Greater Vancouver Market Snapshot August 2013

Below are updated sales, inventory and months of inventory graphs for Greater Vancouver to August 2013. (see REBGV news releases) (click on image to enlarge)

The scatterplot of 6 month price changes and months of inventory is below. The most recent datum is the brown dot at about (MOI=7,price_change=3%) . The trend is roughly in line with past years. The other graph I have added is the price-rent ratio for a Greater Vancouver apartment, using REBGV apartment MLS-HPI and CMHC-reported rents (extrapolated, as they are only reported once per year), normalized to January 2005. By this measure, price-rent is currently 15% above its value in 2005 and 27-64% above the range of values from 1992-2004.

My estimates for August were for inventory of 16365 (actual 16027) and sales of 2469 (actual 2514) based on estimating average changes from July of years 2005-2012. Using the same technique estimates inventory and sales for September of 16663 and 2353 respectively (MOI=7.1).