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Bond Market40 Million Canadians!

40 Million Canadians!

The estimated population of Canada has reached 40 million (link to Statistics Canada information). Although reaching that level is not particularly important, it highlights a shift that is somewhat surprising for those of us not paying close attention to Canadian statistics. The figure above highlights the increase in Canadian immigration, particularly after the pandemic dip (which reflects the border closing). I have never needed to pay attention to Canadian demographic data before — since population growth was quite slow due to falling rate of births. Although immigration was a source of population growth, it was not too significant. However, population inflows are a factor that cannot be ignored, and they matter for the “Canadian Housing Crisis” debate.

One thing to keep in mind that I believe the series I plotted above includes net international student flows, which are large. The United States made it more difficult for foreign students to enter, and so there was a hefty reallocation into Canadian universities.

(Statistics Canada has an interactive dashboard of population statistics here, for people who want to take a look at the data presented in way better than I have time to do.)

Housing Bubble (or Not?)

This leads into the status of the Canadian Housing Bubble. Researchers at the Dallas Fed have created a database of international house prices, and I have seen people plot the same chart multiple times, comparing the house price to income ratio of Canada versus the United States. The chart looks crazy, but I believe that it is missing some context. All the versions that I have seen have dumped multiple countries into the same chart, I have instead just shown Canada. I have not had time to look at the data, but it seems consistent with other data that I have seen. (One of the problems with Canadian data is the limited availability of housing data.)

  • The top panel shows nominal house prices (according to whatever series they used) and nominal disposable incomes. I have rebased both series to 100 in the first quarter of 2000, for reasons to be explained. The immediate problem with these data is that they are indices, while the sensible initial comparison is nominal house prices to nominal incomes.
  • The bottom panel shows the ratio of the two indices (rebased to 100). Since this is a ratio of an index to an index, its level has no economic significance; all we can so is see whether it is rising or falling.
  • I chose 2000 as the rebase point because that is roughly when Canadian house prices took off, forming a hockey stick chart. (The house price data chosen by the Fed researchers puts the hockey stick somewhat later.) However, that level was not a “fair value”: house prices in Canada (outside of a few localities) was cheap. Winnipeg and Montreal (the two cities I have mainly lived in) essentially saw no nominal house price between 1980 and the mid 1990s (working from memory on the CREA house price series that I no longer have access to). We bought our first house (a 3 bedroom townhouse) in Montreal at the end of 1998 at a price that was about 150% of the median Canadian after-tax household income. I believe that a closet in London (England, not Ontario) would have cost about the same at that time at the prevailing exchange rates.
  • The cheapness is not obvious in the chart above, but one may see that the bottom panel ratio shows it is roughly the same in 2000 as in 1980 — and interest rates were considerable higher in 1980.
  • Real estate is local, and there were two large pockets of high house prices — Vancouver (and Victoria) and Toronto. Vancouver is easily understood — it is one of the few places in Canada where old people are not risking hip injuries stepping outside of their homes in January, and construction is confined to a handful of valleys amidst a mountain range. Vancouver house prices have been notoriously (relatively) expensive since the 1970s. Toronto has more open space around it, and what has happened there is that people have been forced to commute longer and longer distances to the city centre. It is not surprising that house prices close to Canada’s financial centre are high. Both Toronto and Vancouver had a condo bubble and bust in the early 1990s (coinciding with one in the United States).
  • The hockey stick after 1998 was the result of the progressive loosening of mortgage insurance standards. (All mortgages with loan-to-value above 80% must have mortgage insurance, which must conform to a minimum standard.) This loosening allowed the rest of the country to emulate the experience of the United States where subprime lending became a force in the early 1990s, and also put more fuel into the Toronto and Vancouver markets (which bumped into maximum mortgage sizes).

The above background is aimed at the chart that I have seen reproduced multiple times that allegedly indicated that Canadian house prices were more “overvalued” than American in the mid-1990s. Putting aside Toronto and Vancouver, that was not true until the American housing market broke in the Financial Crisis.

I have been bearish on Montreal house prices since the mid-1990s, and I was concerned after 2010 with what I saw as excessive construction and the collapse in lending standards for mortgage insurance. However, the lending standards were tightened, and the immigration wave blew my “excessive construction” fears completely out of the water.

Grab Bag of Comments

  • If one wants to dig into the state of the Canadian housing market, one needs to look into metrics of borrower vulnerability. That has been a topic on policymakers’ minds since the Financial Crisis, and there is now more data available. I have not had time to dig into these new data sources.
  • Housing bears need to learn to be patient. As long as the labour market is in decent shape, nothing interesting is going to happen. My concern has always been that there will be a nasty self-reinforcing feedback loop: the high level of employment in construction means that if the housing market tanks, it feeds into the labour market. However, that has not happened, and the immigration wave has been enough to absorb any excess supply.
  • There are pockets of silliness, possibly buoyed by dubious cash inflows from overseas. However, this is a story aimed at condo markets in some city centres, and we could just end up with a localised blow up (as in the early 1990s).
  • I find that analysts spend too much time worrying about house prices. Unless you are buying or selling a property, the important concerns for housing economics are debt service and construction activity. What I am seeing locally is that there is such a backlog of construction and renovation projects that there is limited sensitivity to house prices.
  • As for the drop in house prices at the end of the chart, I looked at the Teranet-National Bank House Price Index™️ and I see a roughly 10% round trip up then down from 2021 to 2022 to present. This is not incredibly surprising given the behaviour of interest rates over this period. Although the chart looks ominous, in the absence of another rate hike campaign, a “sideways correction” is an entirely plausible outcome. Conditions were unusual and 2022 and they unwound — which does not necessarily lead into “the bubble is popped and the housing market is taking the express elevator down!”
  • Rising interest rates creates a strain on household finances — particularly since the longest period interest rates can be locked in practice is 5 years. However, a spike has already happened, and the Bank of Canada is well aware of this vulnerability on a forward-looking basis.

Ever since the Financial Crisis, there has been periodic excitement raised by foreign analysts predicting the collapse of the Canadian housing market. Unless the business cycle is upended elsewhere, I would remain cautious.

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(c) Brian Romanchuk 2023


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