Reports

OPINION: Housing starts were better than consensus expectations in October. Following a drop in September, Canadian residential construction increased and continued to perpetuate a level that is higher than demographic needs (estimated to be around 190K). Starts in the Toronto market dropped over 20% after a 34% drop the prior month. A more normal level of the active listings to sales ratio in that city (a measure of the resale market) helps contextualize decays in residential construction (middle chart).

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Affordability worsened for a ninth quarter in a row in Q3, the longest run in three decades. It’s worth noting that the Q3 deterioration – the most acute in 9 quarters – was exacerbated by the impact of higher mortgage rates resulting from Bank of Canada summer rate hikes (top chart). At the national level, more than 70% of the deterioration in affordability was due to higher interest rates; in Toronto, it was 90% (top chart). In Vancouver, affordability fell by the most since 1994 as potential homebuyers were also hit by a surge in home prices. As of Q3, the Toronto and Vancouver markets are now the least affordable since the early 1990’s (middle chart). Given the Bank of Canada’s stated intention to continue the normalization of monetary policy over the coming year, we expect a cumulative increase of about 100 basis points for the 5-year mortgage rates from the trough. Historically, such a change may have had a limited impact on the housing market but this time could be different. Twenty years ago, a 100 basis points increase in mortgage rates would have caused a deterioration of our national affordability measure by 3.5 percentage points. Today, a similar increase has an impact 60% larger given much higher home prices. The Toronto and Vancouver housing markets are particularly more sensitive to rising interest rates compared to other cities (bottom chart). This, combined with more stringent qualifying criteria for uninsured mortgages announced last week by OSFI, means that those markets are poised to experience home price declines in 2018.

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OPINION: September’s decline of the national composite HPI is the largest in seven years (top chart), due to the fall of Toronto’s index. The Toronto’s unsmoothed index (see note on methodology next page), has shrunk in each of the last three months, for a cumulative loss of 7.5% (middle chart). Many might worry about the fact that the last time we saw a string of monthly declines of such magnitude was during the last economic recession. They should not. Market conditions on Toronto’s home resale market went from being very tight at the beginning of the year to balanced, as suggested by the active-listings-to-sales ratio which, at 2.5, stood at its average long-term value in September (bottom chart). The ratio is still very far from its peak level of 6.5 experienced during the last economic recession. Moreover, market conditions appear to have stabilized over the last four months. If that is the case, a large part of the price correction to be seen in the Toronto home resale market might be behind us.

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OPINION: The recent loosening of the Toronto home resale market translated into Toronto’s HPI dropping in August. In fact, Toronto’s unsmoothed index (see note on methodology next page), which had already dropped in July, fell 4.2% in August (top chart). That being said, Toronto active-listings-to-sales ratio, an indicator of market conditions, turned from being very tight early in the year to indicating a balanced market in August (at 2.5, its value was in line with its long-term average – middle chart). This should limit the potential for further price correction in the Queen City. Yet more price declines cannot be ruled out given the expected tightening of qualification rules for uninsured mortgages and interest rate increases. These factors are expected to have the most impact on prices in markets where homes are the most expensive (Toronto and Vancouver). We expect home prices to be more resilient in other markets, such as Montreal which has been hot this summer (bottom chart).

OPINION: The recent loosening of the Toronto home resale market was clearly felt on Toronto’s (unsmoothed) subindex for dwellings other than condos, which declined 1.6% from June. Moreover, after seasonal adjustment, this subindex declined 2.2% (see middle table). Based on a survey of real estate boards that we conducted earlier this month, home sales declined on a y/y basis in July in most large Canadian cities west of Ottawa. If that trend persists, home price growth might decelerate in these regions. That being said, home resale markets are rather hot this summer in Montreal (bottom chart) and Ottawa-Gatineau, two areas where the Teranet-National Bank Home Price Index was at a record level in July. Home resale markets have also improved markedly of late in the Maritime Provinces. So, pressure on home price growth that might result from rising interest rates and regulation changes are likely to not affect regional markets evenly. Downward pressure is likely to be more acute in regions where affordability has been eroded by past price escalation, while home prices should be more resilient in regions where homes are more affordable.

Q2 2017: The least affordable market in 9 years

The worsening of affordability in Q2 was the eighth in a row, the longest run in almost 3 decades. As a result, our national composite is the least affordable since 2008 (top chart). Canadian households have been able to fall back for some time on the condo market which was more affordable on an historical basis. However, the deterioration in Q2 was more acute in this segment compared to other dwellings. As a result, even the condo market is now the least affordable in years (worst since 2011). Yet again this quarter, there is still a significant divergence across regions with no less than 6 markets showing an improvement of the situation in contrast with British Columbia and GTA cities that experienced further deteriorations (middle chart). The deterioration of affordability in Canada over the past two years appears to be negatively impacting consumer confidence. The latter is shown by the index related to “whether it’s a good time to make a major outlay such as a house” diverging substantially from the index grouping other questions of the survey (bottom chart). We note that despite labour markets being essentially at full-employment in Ontario and British Columbia, the percentage of respondents considering it a good time to make such an outlay is barely above Alberta’s level which is still coping with the pinch of the oil shock. The mortgage rate hike observed so far in the third quarter will certainly not alleviate this sentiment going forward.