NOVEMBER 11, 2012
This is the third and final post detailing my thoughts on the much-publicized "No US-style housing crash for Canada" report written by Ben Tal of CIBC. Please also see part 1 and part 2. The CIBC report can be read here.
Two final areas of disagreement:
1) The degree of potential overbuilding vis-a-vis the US at peak
From Tal's report:
On average, over the past decade, housing starts in Canada exceeded household formation by only 10%—with most of the excess seen in cities such as Toronto and Vancouver. In the US, the gap during the decade leading to the crash was almost 80%.
I'd be curious to see how Tal derived this conclusion. Once adjusted for population, housing starts in Canada over the past decade have significantly outpaced housing starts in the US in the 10 years leading up to peak. In fact, if final housing starts come in around 215k this year, in line with their current pace, it will represent a pace of construction comparable to 2004 in the US when the housing bubble was nearing its frothy peak.
Ultimately, household formation rate is determined primarily by population growth, though it can, and virtually always does accelerate beyond what population growth would warrant during boom years when credit is easily accessible and the drive towards homeownership is particularly strong. Of course the opposite is always true, and is one reason I fully expect housing starts to fall well below the estimated Canadian household formation rate of 185K once housing falls out of favor.
That said, perhaps the easiest way to compare the level of construction in Canada and the US is to simply look at housing starts relative to population change. When we do this, we find that in spite of a precipitous plunge in Canadian housing starts in 2009 and 2010, the pace of new residential construction in Canada relative to population change over the past decade has nevertheless been greater than the US experienced in the 10 years leading up to their peak. While the US built one new dwelling for every 1.70 people added to the population from 1997 to 2006, Canada added one new dwelling for every 1.67 new people added to population between 2003 and 2012:
And by the way, this is not simply Canada "catching up" after years of under-building. In fact, once we again adjust for population, Canada currently has a higher total housing stock (i.e. total number of dwellings) than the US had at peak.
How the report concludes that US homebuilders massively overbuilt relative to Canada is a bit of a mystery to me.
2) Negative equity position??
An interesting quote from the Tal report:
"In Canada, the negative equity position is nil, and only 15-20% of new originations have an equity position of less than 15%."
I think this is a sleight of hand. Let's not confuse this as saying that only 15-20% of first time buyers make a downpayment of less than 15%. There's a bit of trickery in the way this is worded.
In Canada, mortgages typically come up for renewal every 5 years, whereas in the US, most mortgages never need to be renewed as the standard mortgage carries a 30-year term. That being the case, if we include mortgages being renewed after at least one 5 year term in a rising real estate market, of course "NEW" mortgages appear to have substantial equity in Canada.
A far more telling stat would be to compare average first time buyer down payment in Canada vs the US. While I suspect it would still be higher in Canada at present relative to the US at peak, I doubt the difference would be noteworthy.
1) The real housing story in Canada lies in the degree to which our economy has been driven and sustained by this current boom
Residential construction and the FIRE industries (finance, insurance, real estate services), which collectively serve as a proxy for housing activity in the broader economy, are at by far all-time highs in terms of their contribution to total GDP.
Likewise, their contribution to employment, particularly full-time employment, remains at all-time highs.
And we currently have a $60B annual flow from housing equity into the broader economy, supporting consumption and additional investment in the real estate sector. This level of home equity withdrawal is on par with levels seen in the US at peak when compared to aggregate disposable income.
How any of these will remain at current levels in the event of a "soft landing" in real estate is an enormous question in my mind. If the underlying economy and labour market erodes significantly as a result of a soft landing, will it remain a soft landing? So while a "US-style" crash may be unlikely, a housing correction of even half the magnitude experienced in the US represents an economic shock that will most certainly overwhelm the current ~2% annualized GDP growth rate and plunge us into what would likely be a long, drawn-out recession.
2) Insights into Canadian bank censorship
Finally, and at risk of being accused of character assassination or strawman arguments, I want to reveal some insights into how banks censor some of their analysts. I should clarify upfront that these comments are not directed at Mr. Tal or his report, which I'll once again say represents one of the more balanced and insightful reports from the big banks in some time.
In my current role, I've gotten to know a number of excellent analysts and economists who were or currently are employed by Canadian banks and who to varying degrees share my concerns over the housing situation in Canada. Each one has separately told me of specific incidences in which "bearish" reports they had written received backlash from upper management, or they were forced to remove portions of their reports before they would be circulated.
Two of these analysts were told in no uncertain terms that they could not discuss their perspective on housing with the media. Two will only discuss housing-related matters with me via phone and not through their work email. One relayed an amazing story of a CMHC report they wrote in which they expressed some concerns with current CMHC policy and the pace of growth in their insurance in force. The day their research note was released, bank execs received a call from a CMHC exec. The report was pulled and the bank immediately issued an apology. All of them told me in no uncertain terms that "overly" bearish commentary on housing is simply not permissible for a bank-employed analyst.
All that said, I suspect most bank analysts legitimately do agree with the sentiment expressed in the Tal piece, but don't kid yourself; There are those who strongly disagree....but you'll never hear it.
Canadian bank reports are used as a source in many media articles on important macro issues such as housing. As with anything else, we'd be wise to consider the source. As seen below, the chartered banks have balance sheets with significant exposure to mortgage, consumer, and business credit, the performance of which are to varying degrees reliant on the ongoing strength of the housing market and broader economy. Some banks are far, FAR more exposed than others. They know full well the balance sheet and earnings risks associated with a housing correction and the economic fallout it would induce. Don't think for a moment this doesn't colour their perspective on these issues.
I'll be discussing these topics and many more when I visit Vancouver later this month. You can reserve your complimentary tickets here.