BC Population Growth to Q3 2011

BC Stats just released (PDF) its quarterly population estimates and BC continues sluggish growth through Q3.

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 Q3-2011 data indicate continued negative net interprovincial migration, but a marked increase in nonpermanent residents (NPRs). (NPRs mostly consist of students and temporary workers.) Q3 usually sees an increase in NPRs due to arriving students commencing collegiate pursuits in September. The most recent CMHC rental survey indicates decreased rental vacancy; the increase in NPRs provides some evidence supporting the lower reported vacancy rate.

Below are graphs of NPR migration and annual population growth up to 2010:

Weak population growth in Q4-2010 through Q2-2011 has further extended into Q3-2011, and Q3 is respectable mostly by virtue of increased NPR in-migration and not permanent residents. These recent population data are what I would characterise as a continuing bearish indicator for BC real estate, especially for owner-occupier dwelling formation.

Y U No Spend?

Bank of Canada governor Mark Carney is speaking again -- again -- this time to businesses, on how to pull Canada through what looks to be a period of uphill growth (emphasis mine):

Canadian households increased their borrowing significantly. Canadians have now collectively run a net financial deficit for more than a decade, in effect, demanding funds from the rest of the economy, rather than providing them, as had been the case since the Leafs last won the Cup. 

Developments since 2008 have reduced our margin of manoeuvre. In an environment of low interest rates and a well functioning financial system, household debt has risen by another 13 percentage points, relative to income. Canadians are now more indebted than the Americans or the British. Our current account has also returned to deficit, meaning that foreign debt has begun to creep back up...

In other words, households are chasing diminishing returns and the point at which this debt will be impossible to properly service is a looming risk.

Our strong position gives us a window of opportunity to make the adjustments needed to continue to prosper in a deleveraging world. But opportunities are only valuable if seized.
First and foremost, that means reducing our economy’s reliance on debt-fuelled household expenditures. To this end, since 2008, the federal government has taken a series of prudent and timely measures to tighten mortgage insurance requirements in order to support the long-term stability of the Canadian housing market. Banks are also raising capital to comply with new regulations. Canadian authorities are co-operating closely and will continue to monitor the financial situation of the household sector. 

To eliminate the household sector’s net financial deficit would leave a noticeable gap in the economy. Canadian households would need to reduce their net financing needs by about $37 billion per year, in aggregate. To compensate for such a reduction over two years could require an additional 3 percentage points of export growth, 4 percentage points of government spending growth or 7 percentage points of business investment growth. 

Any of these, in isolation, would be a tall order. Export markets will remain challenging. Government cannot be expected to fill the gap on a sustained basis. 

But Canadian companies, with their balance sheets in historically rude health, have the means to act—and the incentives. Canadian firms should recognize four realities: they are not as productive as they could be; they are under-exposed to fast-growing emerging markets; those in the commodity sector can expect relatively elevated prices for some time; and they can all benefit from one of the most resilient financial systems in the world. In a world where deleveraging holds back demand in our traditional foreign markets, the imperative is for Canadian companies to invest in improving their productivity and to access fast-growing emerging markets.

This would be good for Canadian companies and good for Canada. Indeed, it is the only sustainable option available. A virtuous circle of increased investment and increased productivity would increase the debt-carrying capacity of all, through higher wages, greater profits and higher government revenues. This should be our common focus.

Carney is pleading with businesses to invest to make up for what household spending has done in the past 3 years (and longer), in part by expanding enterprises away from Europe and the United States where growth prospects look anaemic. It appears that increases in -- or even the maintenance of -- the average household debt-to-income ratio will be a trigger for further tightening of credit availability.

Carney has also provided confirmation that banks are increasing their capital reserves for household loans, which means less credit will be available going forward and banks will need to be more selective in the loans they make. It is unclear what criteria banks will use to ration their loans but may involve regional considerations, as was done by HCG earlier this year.

The Bank of Canada is trying, with the limited tools it has available, everything it can to get businesses to spend. If businesses do not spend the burden will be borne by households and governments and this, in Carney's view, is the outcome most likely to lead to subpar (or negative) economic growth. The federal government has been attempting to facilitate private investment through tax breaks and other investment programs, but now Carney, at least, is appealing to patriotism. That is a wonderful stance in principle.

Bank of Canada Blows the Alarm on Housing Again

As the Eurozone crisis continues its slow impact with the current account iceberg, Canadian financiers, politicians, and technocrats (yes Canada has technocrats too) are planning for fallout (PDF). One key area of concern is the health of Canadian household finances. Below are excerpts from the risk analysis of Canada's housing market (emphasis mine):

The rising indebtedness of Canadian households in recent years has increased the possibility that a significant proportion of households would be unable to make debt payments in the event of an adverse economic shock. This growing vulnerability has heightened the risk that a deterioration in the credit quality of household loans would amplify the impact of the shock on the financial system. The resulting increase in loan-loss provisions for financial institutions and the reduced quality of the remaining loans would lead to tighter credit conditions and, in turn, to mutually reinforcing declines in real activity and in the overall health of the financial sector. 

The vulnerability to this risk remains elevated and is broadly unchanged since June. There are tentative signs that the sustained rise in the proportion of vulnerable households in recent years has moderated and credit growth has slowed noticeably over the past six months. Nonetheless, our simulation results suggest that household balance sheets remain vulnerable to adverse economic shocks... 

While the growth of household credit has slowed since early 2011, it has continued to increase more rapidly than income. As a result, the debt-to-income ratio of the Canadian household sector increased to a historical high of 149 per cent in the second quarter (Chart 23) and has been higher than the ratio in the United States since the start of 2011.

If recent trends persist, the ratio of household debt to income will continue to rise

Despite the rebound in the growth rate of mortgage credit in October, the Bank expects a gradual moderation in the underlying trend in household debt accumulation over the medium term as activity in the housing market slows and as lower commodity prices and heightened volatility in financial markets weigh on the wealth and confidence of Canadian households. Since the growth of personal disposable income is also projected to be moderate, the gap between credit and income growth is expected to narrow but remain positive, implying that further increases in the aggregate household debt-to-income ratio are likely. 

The overall financial situation of households remains strained  

Data for both individual households and the sector as a whole indicate that the financial situation of the household sector remains vulnerable. In particular, both the share of indebted households that have a debt-service ratio exceeding 40 per cent and the proportion of debt owed by these households remain above the 2000–2010 average.
The aggregate credit-to-GDP gap for Canada has fallen from its cyclical peak but remains high by historical standards, owing to the growth in household credit. International evidence has shown that this indicator is a useful guide for identifying a potential buildup of imbalances in the banking sector. 

Financial stress in the household sector has eased since the beginning of 2011, although it remains above pre-crisis levels: mortgage and consumer loans in arrears have moderated somewhat during 2011 but are nonetheless elevated. As well, the ratio of household debt to assets remains above its pre-crisis level, and household net worth declined modestly in the second quarter. Given negative returns across a broad range of assets since mid-year, net worth is expected to have declined further in the third quarter. 

Households are vulnerable to adverse shocks to the labour and housing markets 

Given the vulnerable state of their balance sheets, households would be less able to cope with the impact of significant adverse shocks. Two interrelated events to which Canadian household balance sheets are vulnerable are a significant decline in house prices and a sharp deterioration in labour  market conditions. 

Since high-ratio mortgages in Canada are insured, it is likely that a moderate fall in house prices would affect systemic risk primarily through the negative feedback loop with the real economy. In such a scenario, declines in house prices would lead to lower household net worth, reduced access to secured credit and lower employment in the housing-related sector. These factors would reduce consumer spending and increase strains on household balance sheets. 

Some measures of housing affordability suggest continued imbalances, owing to the robust performance of this market. In particular, house prices remain very high relative to income. Since the adverse impact of elevated residential property prices on affordability has been largely offset by low interest rates, affordability would be considerably curtailed if interest rates were closer to historical norms.

Certain areas of the national housing market may be more vulnerable to price declines, particularly the multiple-unit segment of the market, which is showing signs of disequilibrium: the supply of completed but unoccupied condominiums is elevated, which suggests a heightened risk of a correction in this market. 

A sharp and persistent increase in the unemployment rate would reduce aggregate income growth and make it more difficult for some households to make their debt payments. It would also have adverse knock-on effects on consumer confidence, the housing market and Canadian household net worth. 

The elevated debt loads of the household sector require continued vigilance

The Government of Canada has taken important measures in recent years to strengthen underwriting practices for government-backed insured mortgages. The most recent set of measures was implemented in March and April 2011, when the maximum amortization period was reduced from 35 to 30 years, the maximum loan-to-value ratio when refinancing a mortgage was lowered from 90 per cent to 85 per cent, and government-backed insurance on lines of credit secured by houses was withdrawn. These measures represented the continuation of a series of actions taken by the Government of Canada since 2008 to foster stability in the domestic mortgage market, and should help to moderate the future growth in household debt. Nonetheless, continued vigilance is warranted, since adverse debt dynamics remain in place. The Bank is co-operating closely with other federal authorities to continuously assess the risks arising from the financial situation of the household sector. 

Given the robust pace of mortgage credit growth in recent years, the Office of the Superintendent of Financial Institutions has conducted focused research on retail lending products over the past 18 months. An advisory was recently released noting that additional analysis is planned in the coming months. Where appropriate, this analysis will build on international mortgage underwriting principles being developed by the Financial Stability Board. OSFI has reiterated that mortgage lenders are expected to have an established policy for mortgage underwriting that is supported through appropriate risk-management practices and internal controls.

Key points and comments:

• Household balance sheets are likely to deteriorate further in coming months, and potentially years, with current controls in place.
• The Bank of Canada sees high house prices relative to incomes as unsustainable in the long run.
• OSFI is concerned about a disconnect between bank lending practices and long-term economic stability.
• Curbs on lending in terms of implementing risk management measures and countercyclical buffers on mortage loans are likely in the works.
• Usually announcements of further tightening of mortgage credit are announced in the first two months of the year to allow for proper implementation before the brunt of the peak of Canada's spring selling season.

If the Bank of Canada feels the need to lower interest rates in early 2012, this paper suggests that they are seriously considering additional curbs on mortgage lending to offset any additional monetary stimulus. This may mean, in particular overheated regional markets (like Vancouver's), that OSFI will start enforcing measures more closely tied to regional price-income metrics. This means Vancouver homeowners may find credit availability tougher than other regions of the country.

This is an important report. I have been surmising that further curbs in mortgage lending are coming, but am still unsure what form they will take. It is still possible that curbs going forward will start delving into the low-ratio mortgage market -- if prices do start falling banks who are lending on terms incompatible with government-backed mortgage insurance will create a significant liability for Her Majesty's Government.

Greater Vancouver Market Snapshot November 2011

Below are updated sales, inventory and months of inventory graphs for Greater Vancouver to November 2011.

And the detached benchmark price:

Commentary: November 2011, continuing from previous months, has produced more tepid sales numbers than years past. Months of inventory (MOI, the number of months it would take to clear month-end inventory at current monthly sales levels), a key indicator of market liquidity and impending price strength, is at about 6, a level concomitant with flat prices.

Total inventory has likely peaked in October (it peaked mid-month, but not shown due to monthly sample rate); if the market were under significant distress we would have expect increased inventory buildup through November, which did not happen. New listings have been consistently about 20% higher in 2011 than 2010 with sales roughly flat. That indicates a greater percentage of listed properties will be unable to elicit a sale.

Below is the predictor of price gains, based on half-over-half price change to months of inventory correlation:

What this shows is the change in prices in a month from 6 months ago based on actual data and “predicting” the price based on months of inventory from that month based on linear regression of half-over-half price change to months of inventory (with 3 month moving average).

In summary November 2011 has mirrored November 2010 closely, with slightly more weakness due to higher inventory levels and lower sales. December and January are slow months for listings and sales, so while the reports may be of some interest there won't be much to draw any meaningful conclusions. It is likely that severe market distress, should it occur as in 2008, would only be evident going into the summer, validated by robust inventory growth and increasingly slower sales. While I am not calling for such an event in 2012, there are real and tangible risks of it occurring based on slower population growth, increased dwelling starts, slower GDP growth in Asia, and potentially further mortgage lending restrictions in overheated markets like Vancouver's.

Elections and the Unspoken Fear

I have been following local Vancouver City election campaigning of late. I have been particularly interested in looking at the various platforms aimed at combating housing "affordability" and "speculation" in Vancouver. Various parties and candidates offer potential solutions to solving "affordability" and "speculation", ranging from "cutting red tape", adding low-to-medium-income rental housing, changing the housing mix, embedding neighbourhoods in the planning process, to outright curbs on foreign ownership.

I think, though, there is a lack of debate surrounding high prices in general. Most candidates seem to understand that prices are high but few seem convinced, at least publicly, that prices are destined to drop. All debate seems to surround the possibility that high prices are here to stay as Vancouver "graduates" into the ranks of a world city with commensurate high prices. This may simply be that telling homeowners prices -- and their homeowner equity -- are destined to fall is unpopular it wouldn't garner popular support, but after listening to the candidates speak, Tweet, and comment, I come away with the impression that crashing prices experienced by our urban Cascadian neighbours to the south are almost entirely foreign.

Nonetheless the assumption of high prices leaves me feeling raw, first that prices are obviously in a speculative bubble as measured by price-income and price-rent ratios. The evidence supporting prices remaining high is suspect, it relies on a continuous flow of foreign capital and continuously low interest rates. Most purchases of property in the Greater Vancouver area (though perhaps not certain sub-areas) are by locals with locally-derived incomes. By that measure it's a relatively simple exercise to calculate how much foreign investment would be required to keep prices from dropping, and it amounts to something approaching British Columbia's annual GDP.

Given that house prices are on an earnings basis a poor return on investment, we should be asking first whether these poor earnings are in the long-term best interests of Vancouver's economic growth. Second, if we determine that expensive house (actually, land) prices are a net harm to economic output, we should be asking a big question: is it possible and desirable to suppress land prices to enable more stable and diverse economic growth?

Keeping land prices low is not an unheard of concept. Through various schemes surrounding limiting leverage, land use plans, landlord and tenant protection legislation, and taxation various jurisdictions have been more (though arguably not wholly) successful at reducing land speculation. Parts of Texas and Germany have done this.

No easy answers -- and no doubt simplistic suggestions the blogosphere seems to be prone to peddling are riddled with flaws -- nonetheless I dismiss chronic boom-bust cycles that have plagued Vancouver are not controllable using thoughtful and long-term feedback mechanisms.