Canada Housing... Bubble?
The problems with housing starts with an inconvenient point. Despite the vastness of our empty country searching for relevance, most people want to live in half a dozen places. Particularly two that get the most discussion (Toronto & Vancouver). Both of which have water and transportation issues somewhat boxing them in. Anyways everyone agrees they're ridiculously expensive, particularly for the young family.
Mostly answers to such problems there are two simple answers.
1: Move elsewhere. While sounding simple, people understandably don't want to listen to the "it's not that hard, just leave the place where you were born and raised that has all the jobs" argument. That's fine, so we should go to option 2
2: Build More. Easy right... Right... Here's my biggest problem with some of the complaints. (Let's pretend that people don't fight against development). It's expensive to build.
Building:
You need Land
+
Plan
Plan includes zoning, building permits, engineering work
+
Money
Your capital, debt, backing for the risk (pre-sales)
+
Incentive
Developers need to have a reason to develop, so that's profit - tax paid - interest
If you add up all the costs, you get something like this
In other words, if you want more supply, you need prices at that level minimum. Recently I saw someone talking about the ridiculous price of Toronto condos... the same person a few weeks earlier was asking 'now that prices are almost such that developers can't make money, what do they do? will they sell at a loss or wait?' I CAN'T MAKE THIS UP... but this story explains so much... why do developers pre-sell units to investors? Why hasn't supply been more responsive in 'bubble' prices? Why have prices been so high for so long? INCREMENTAL SUPPLY IS VERY EXPENSIVE. A bubble... with costs close to construction costs.
Beyond that you need policy to help (and there's definitely policy available to help)
If you work that out as a baseline to compare against, the market isn't that bad.
On the other hand, if you look at what has happened in the market, the obvious levels of shooting ourselves in the foot is killing me.
Mechanically: Raise rates= raising payments
So we've collapsed the incentive to produce more supply while artificially made housing less affordable 👍👏👍👏.
At least immigration has been lower so the market can catch...
... Nevermind.
Ok but we must be working off a very high production base... After all prices are in "bubble territory" in some people's minds.
That's a matter of perspective
My perspective is: no... but I'm sure some would disagree. Like, it would be high if population growth was at 2005 or 1970 or 1985 levels... but last year we added 2.5x the growth that we had in those periods.
Even within the G7 Canada has low housing stock
Compared to the US population growth & starts
So here we are... Market so concerned about 2008/9 that we're being cautious with investment.
Ironically, prices had received declined more on a % YoY basis than they did in the GFC.
I've all but given up trying to explain why I'm super bullish on developing real estate in Canada longer term. It hasn't mattered for months. I get it, price is going to hurt with rate hikes or a weaker economy. I also understand that my volume businesses may take a hit because of the margin hit and caution.
Do you see how that makes the problem worse (investment outlook better) afterwards?
What I believe the main constraint should/will be is labor. At this moment I'm sure some genius is about to tell me how rate hikes will help with that because the layoffs from interest rate sensitive sectors (like housing) will provide labor. But my point is there is a realistic concern about the right skilled labor availability to build as many dwellings as we'd need. I think the market will mostly figure it out but I also don't see why we need hundreds of thousands of tech worker immigrants but don't bring immigrants who want to build homes.
Hate on Pre-Con sales
One narrative that really grinds my gears is the hate out there for people 'speculating' on pre-constructed condos. (P.S. I've never done this). Builders need capital to develop $250M buildings. Banks don't want to take price risk, nor do builders. So builders often need to sell units before they build. Given that the entry home buyer uses their home as a place to live, they're less able to dish out large amounts of money years before there's a place to live. Investors step in and fund the development.
Yes, you understood that right, without those speculators that get all the hate, there'd be less supply and even higher prices. No... Adding speculative supply isn't jacking up prices. I understand it's an emotional topic but please think logically.
I know someone is going to read this and want to tell me why they're evil for different reasons. "They're funding the wrong type of housing, they're adding one bedroom that no one wants" again, I understand that people see the need for more family sizes units but understand that those take much more space and much more money to build. Understand also that if there weren't huge amounts of demand for those (despite the narrative) that prices & rents would look different and the market would react differently.
Demand to live in Canada and those cities has been enormous. It certainly hasn't been handled perfectly but the situation is far less inexplicably crazy or bubble-like than many imply.
People really hate people keeping properties as investments but again, they put up the same capital that can be used to build more and use that unit to (in their own small way) push down rent prices. Every unit rented out is added supply. Added supply reduces rent.
1988
There was a news article from 1988 about how unaffordable Toronto was. Seen Here Everyone wanted to be there then and everyone wants to be there now. Things that everyone wants, not everyone can have. That comes out by things being deemed unaffordable. P.S. if you invested in a condo in 1988, you did ok on price. If you include the leverage that a mortgage would provide, you did great financially.
Gold vs Toronto
Toronto Real Estate is a bubble... I mean according to everyone... But is gold?
Prices that keep going up always inspire people to jump to bubble conclusions. Meanwhile, a crappy currency like ours (not complaining, there are certainly far worse) loses value all the time. If populations are going to grow, costs of real estate will be tied to costs of production. Declining currency into a broadly increasing economy means more wealth chasing the most core in demand locations... Higher demand. Some people's ideas of affordable may not match the realities of building a house. Plus as Tim Melton put it, Even back when houses were under $20'000 all people could talk about was how expensive they were. The more things change, the more they stay the same.
Taxes
Speaking of costs of production... I think people would be astounded at how much of the cost of new housing is essentially tax. This report Will Feds Answer the Call identifies the huge percentage of the cost of production that is effectively tax. hint it's HUGE.
It's also been growing as a share
It's pretty crazy to think about. At 5% interest rates it's mean paying an added $1200 per month in interest... just on the tax
So if we want to improve this in a sustainable way this is, to me, the simplest, best and least intrusive way to make things much better. (Targeted tax breaks for certain aspects of the industry). I think we could get prices down 25% with the right policy... Of course that would be temporary as the currency depreciation aspect and others will essentially mean over time prices likely keep going up.
FHSA
The FHSA isn't the best idea but isn't the worst. It also demonstrates a willingness for a targeted solution. For those not following: the First Home Savings Account or (First home tax free savings account) is something that I believe most young, income earnings non home owners should look into. It's tax deductible like a RRSP but has the benefit of not being taxed in the future (like TFSAs) the catch being that it must be used towards the purchase of a first home within a certain (but quite long) time. It's targeted because only non-homeowners can open one. Imperfect because on a basic level, if everyone has more money to bid for a price that doesn't improve the competition dynamics.
Interest Rates
People (who ignored history, logic and data) thought that higher interest rates would make housing more affordable. It's an easy story to tell yourself. Rates up = price down... that must be good for affordability right? WRONG. The price goes down BECAUSE there's less affordability at the prior price. Affordability only improves when rates stop increasing. Homes aren't bought all cash, what's actually purchased in an ongoing payment. Although the price goes down, the payment actually goes UP. Don't take my word for it, look at the last 50 years of data and see if you can see what happens to affordability ever time interest rates are raised.
Unfortunately, it's even worse than that... We agree that interest rate hikes drive down prices... so let me ask you, with lower prices, foes that incentivize more or less supply?
Unfortunately, it's still even worse than that... Building houses is expensive. Lots of money is needed up front to build. Raising interest rates is the definition of making that money more expensive. Just like with taxes... that cost must at some point be passed on to end buyers... or result in less volume at the margin.
We're really stupid.
ACTUAL IDEAS
Cut taxes on labor, materials, land transfer, development, sales etc.
Ease zoning restraints, if people want to spend lots of money on building residences don't make their life hell.
Also, if someone wants to replace an office building with residences... let them
Offer developers lower interest rates for their construction.
Look, I've probably convinced no one of anything. So here's my suggestion. If you believe that houses are ridiculously expensive, build one and sell it... Make a fortune... if you can.
Release Valve
It does bring up the question of a release valve. I mean we didn't solve much on pricing in this post... We just looked at why it's the case. So if people can't afford to live in downtown Vancouver, where can they afford?
Perhaps more interesting, why is there cheaper? After all, one of the best arguments I've heard for being bearish an asset with thousands of years of track record of being an appreciating asset is that it's just too dang expensive an entry point. The answer I come to is, 1: cheaper land. 2: easier permetting (less development timeline) 3: more favorable construction industry. IE lower costs, lower costs and you guessed it... lower costs.
The one I keep seeing, perhaps because all the options in the public equity market seem to point there, is Alberta. Alberta had both spare capacity from the last oil boom & one of the most conducive building environments... Also with spare capacity. Well, they've tightened significantly last year along with much of the rest of the country.
Note: Q1 of 23 was 'only' 45k (source Statistics Canada & me)
Just because I give you This table of declining vacancy rates doesn't mean that the market cares.
In reality we're nowhere near the equity prices of the last time people cared about Alberta. We're perhaps on average 1/3 of the valuation vs last time. On one hand that makes sense. People got burned by the excitement last time. We still haven't recovered from that. People now look at any boom as an inevitable bust. On the other hand, in the last cycle, such a ridiculous amount of money was first made in Alberta (pre 08)... That expectations may have became unhinged. My favorite anecdote is a company (which I didn't own then) that increased their dividend 100x through the cycle. Another company with land in the region was trading at 3x book value. Today the first company trades at 1/3 of their book value & the other, I'd argue the land is free in today's market cap.
We've gone from forgetting busts exist to forgetting booms exist.
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