Housing’s Sizzle Is Set to Fizzle

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Benjamin Tal, deputy chief economist, CIBC.

If you look at the overall situation, clearly the housing market is the number one surprise of the current recession. We have seen the mother of all V-shape recoveries in housing, in terms of sales, in terms of prices, in terms of supply and demand. And the question is why, how sustainable it is, and what is the long-term trajectory of housing given extremely low interest rates?

So, let’s start with the why. We have seen a situation in which prices are rising at about 12, 13% on a year-over-year basis. We basically were able to recover all the ground lost during the recession and more. And some people say this is all pent-up demand and low interest rates, but we have to go actually deeper and see exactly what’s happening there. This is by far the most housing market–friendly recession in Canadian history. And it’s not just about interest rates, because if you look at 2008, activity in the housing market went down. If you look at 1991, it went down. This is the only recession that it did not go down.

Now, it is true that in absolute terms, interest rates now are much lower, but back then in 1991 or in 2008, they did not have stress test. They did not have B-20. If you look at the rate in which Canadians have to be qualified in order to get a mortgage today, for variable and fixed-term mortgages, this rate today is 4.79%. This is actually higher than the rate that, in 2008, households had to qualify that. So, this means that from a qualification perspective, interest rates today are actually higher. Still, activity is improving. So, it’s not just about interest rates. It’s much more than that.

And here we go back to the abnormality, the asymmetrical nature of this recession. More than 90% of jobs lost during this recession were in low-wage occupations. This means that you have a very large segment of the population that were not touched by this recession financially. Their job was there. Their income was there. Interest rates are in the basement. That’s the opportunity that they were looking for, for so many years, and they are capitalizing on that.

At the same time, the people who lost their jobs are mostly renters. They are not playing in the housing market as investors or homebuyers. So, again, the asymmetrical nature of the recession is the secret behind the success of the housing market.

In addition, 60 to 70% of the increase in home price inflation today is due to the composition factor. Namely, more people are moving from small units to larger units — detached housing. Detached housing means more expensive housing. So, inflation in housing is largely due to the fact that there is more activity in the more expensive/larger segment of the market. This is very, very important.

Now, how sustainable this activity is, this trajectory is? And the short answer is it’s unsustainable. After the very strong summer, we are going to see some softening in the labour market as the economy softens during the cold days of winter. I suggest that the number one casualty will be the condo space, where we see a lot of completions, a lot of supply coming, and reduced demand by investors and homebuyers. There is more demand towards low-rise units and, therefore, they will not feel the pain like the condo space.

However, beyond the next six months where we see this adjustment, I suggest that in 2022, 2023 you will see the housing market going back to where it was in 2019. The fundamentals of the housing market haven’t changed. This is a temporary rest, if you wish, impacting mostly the condo space, and we will see this mostly in the next six, seven months. Beyond that, as the economy starts improving in the second half of 2021, I see the housing market recovering very, very strongly.