Hopeful on Housing - Views from the North

Ben Reitzes:

Welcome to Views From the North, a Canadian rates and macro podcast. This week, I'm joined by Robert Kavcic, a senior economist from the BMO economics team. This week's episode is titled Hopeful on Housing.

I'm Ben Reitzes, and you're listening to Views From the North. Each episode, I will be joined by members of BMO's FIC, sales and trading team, to bring you perspectives on the Canadian rates market and the macro economy. We strive to keep this show as interactive as possible, by responding directly to questions submitted by our listeners and clients. We value your feedback, so please don't hesitate to reach out with any topics you'd like to hear about. I can be found on Bloomberg, or via email at benjamin.reitzes@bmo.com. That's benjamin.R-E-I-T-Z-E-S@bmo.com. Your input is valued and greatly appreciated.

Rob, thanks for coming back on the show. It's been, jeez ... I looked back and it saw that it was April of last year. I thought to myself, "I've been negligent for not having you on since then." Clearly, I am. So welcome back, thank you for coming. Appreciate you walking all the way down the hall to join me here.

Robert Kavcic:

Thank you for having me again, sir.

Ben Reitzes:

Rob is what I would call an expert on housing. Definitely, more than me. More than most people. He also is my go-to guy for all provincial fundamentals as well, but we're going to start on the housing front. We're going to touch on the Bank of Canada as well, last week's policy announcement.

But I think the topic that occupies far too many Canadian conversations is housing, so why not add one more to that? Rob, we've seen housing look like it's bottoming in the fourth quarter. Sales were pretty weak to start Q4, in October, November, but they really bounced in December as mortgage rates have come down. Is that a taste of what's to come in 2024? Are we poised to rapidly rebound? Are we going to move sideways for a little bit longer? What does your crystal ball have to say?

Robert Kavcic:

Well, short answer I would say is we are starting to see the market set a floor now. Sales volumes have leveled off, prices have more or less bottomed across a lot of the country. Maybe not so much in some markets around Ontario, but we'll get to that.

So for 2024, I would say the market finds stability through the spring, because there's a lot of pent-up demand out there. We're going a little bit of mortgage rate relief. Psychology is improving too, where everyone now assumes the Bank of Canada is going to cut rates in the second half of this year. Whether it's May or June, or whatever the case may be, the reality is that the market is already starting to look ahead to that so you're seeing more confidence come into the housing market.

I think that sets us up for an environment where market bottoms and volumes come back. The market starts to clear better. But, prices probably don't run too quickly because valuations are still pretty tough. Even in an environment where rates have backed off, valuations are still pretty tough.

Ben Reitzes:

You mentioned two things. Valuations is important, obviously. And pent-up demand. Those two things interact with each other, the supply and demand fundamentals in housing. This is key and I think this is where probably, I don't know, 80% of people get it wrong, in my opinion at least. You share my view. Where is the imbalance? Can we build more houses? Is it even possible to build more houses without more people to actually build them? Where is the pressure? And if there's that much pent-up demand, does it mean prices almost have to, at worst case flatten out? And if you want to be optimistic, maybe there's upside.

Robert Kavcic:

Yeah. There's a lot to unpack here. Supply demand balance is excess demand. Everybody calls it under-building or lack of supply. The reality is it's excess demand. I say that because we physically can't build any more than we already are.

Remember when the Federal budget came out in, I think it was 2022, and they had this very noble goal of tripling the rate of housing construction over the next decade? Sounds great. Our immediate reaction was it's just never going to happen. Because the industry's at capacity, and various other factors. The fact that we're actually still seeing housing starts run at 240, 250, 260,000 per year, after the bank has raised rates almost 500 basis points, is a testament to just how strong the supply side is. We really can't do any more.

We look at it as excess demand. It's come from two main areas. Number one was the bank cut rates to zero, promised Canadians we were going to leave them there for a long time.

Ben Reitzes:

Oops.

Robert Kavcic:

And basically said, "Everybody go out, and borrow and buy houses," and everybody did it at once.

Ben Reitzes:

That worked out really well.

Robert Kavcic:

Yeah. If you cut the top of that, you're obviously not in a good spot right now. There's a big excess demand factor there because there's a big psychological component in the housing market. The minute the Bank of Canada first raised interest rates, the resell market went dead overnight. They cleaned out that excess demand, so to speak. There was still fundamental demographic demand, which is why we think the market is going to bottom out here.

Then, the other part of it is we've gone from, let's say, 4 or 500,000 international immigrants per year, to now 1.2 million, in a very, very short window. It doesn't matter all the great policy measures you push on the supply side. If it's HST rebates, or if it's zoning rules, you can never meet that kind of demand overnight on the supply side.

Ben Reitzes:

You mean you can't build three times as many houses as you thought you were going to need?

Robert Kavcic:

No, no.

Ben Reitzes:

Shocking.

Robert Kavcic:

You're right. The release for all of this is prices. We saw it on the resale side and we're seeing it on the rent side. The rents are running at what, seven, eight, 10 percent per year right now, in the CPI measurement at least. Reality is market rents are stronger than that. The resale side is tougher because the demand is there but people still have to qualify for and pay for mortgage rates that just don't really work at prices that existed 18 months ago. But as those two things balance out, where prices are off 20 or 30 percent in some markets, and if mortgage rates back off somewhere into that 4% range seems to be the sweet spot, then buyers come back in.

Ben Reitzes:

Okay. Well, mortgage rates at least have started to come down. We've seen the five-year fixed come down 100 basis points. It's still around 5%. We're almost in that four handle at least, if not we're a ways to get to 4%.

The government announced a cap on international students, maybe that helps alleviate some of that demand pressure. But personally, I doubt it. If we're still bringing in upwards of, I don't know, 750,000 to a million people a year, we still don't have the capacity to build for all those people, given the backlog that's already in place. Don't think that that measure's actually going to do a whole lot for housing. It just makes things maybe less bad than they otherwise would have been. Maybe that's the way to put it, I don't know. Unfortunately, there really isn't a silver bullet for all this. It's just going to take time unwind all of this pressure. Is there any other way out?

Robert Kavcic:

Time. I would say time. Look at the affordability arithmetic. Prices have corrected, let's say 30%, depending on the market, 20, 30%. Which has been necessary, but they've corrected because mortgage rates have risen. Your actual affordability arithmetic from peak to now hasn't changed at all. If you're thinking of it as a home buyer making monthly payments on a mortgage.

Ben Reitzes:

Yeah.

Robert Kavcic:

Where you actually usually get affordability relief is when you come out the other side of the cycle, where prices have fallen, the Bank of Canada then is able to cut rates. You come into the other side of the cycle, you get some affordability relief. The other good news is the job market has held up really well so if you're getting five, six, seven, eight percent wage growth over time, and it's not tomorrow or the next month, but over a couple quarters, a couple years, you can get some kind of affordability balance.

Is housing going to get cheap in a market like the GTA? It's not going to get cheap or affordable like it was in the early 2000s. That's an era that's just gone.

Ben Reitzes:

Just too much demand, and that demand isn't likely to go away any time soon. I think that's it. As long as the demand pressure stays, and there's no reason to believe that's going to change any time soon, the dynamics overall in the market probably don't move enough to satisfy those looking for "affordable housing." It's going to remain relatively challenging on the affordability side of things.

Robert Kavcic:

The other side of this too is you mentioned the student caps. Conceivably, we could cut half a percentage point off of population growth, maybe in Ontario a little bit more. It doesn't change the arithmetic totally, but it takes a little bit of the excess demand out.

But the thing too, is that there's 350,000 units under construction right now. The vast majority, it's almost all condos. A lot of that's concentrated in the core markets, like the GTA. Believe it or not, that's the most we've ever been building. In per capita terms, we've never been building more than we are today.

Ben Reitzes:

So we're actually building a lot of houses?

Robert Kavcic:

Yeah. Crazy, right?

Ben Reitzes:

Yes.

Robert Kavcic:

But the thing is a lot of that was investor bought, so the intention there I think is to either flip on completion, which a lot of people can't do right now because they'd be negative equity. A lot of that's going to find its way onto the rental market, too.

The mechanics there still aren't great because those people are going to be cashflow negative still, just given where mortgage rates are versus when those contracts were inked.

Ben Reitzes:

Tells you rents still have to go higher.

Robert Kavcic:

Yeah.

Ben Reitzes:

That's what that math tells me, is okay, well if I thought capital appreciation was going to work on this property, it's not, it's cashflow negative given where rents are and where rates are. Rents have to go higher.

Robert Kavcic:

Yeah. If you get all that supply coming in the next 18 months, two years, or whatever the case may be, you maybe get some relief on rent. I'm not saying rents are going to fall, but maybe we go from double-digit rent growth to something more moderate.

Ben Reitzes:

We'll see.

Robert Kavcic:

Yeah, we'll see. The problem is in the CPI, the CPI takes so long to pick this up anyway. That, from an inflation perspective in the CPI, it's way down the road.

Ben Reitzes:

I'm not holding my breath on housing softening here, as much as I wouldn't mind it, even being a homeowner. I still wouldn't mind it. It's just not healthy for the country, it's not healthy for the economy. It's not healthy for society to have home prices go one way and to have the amount of attention that people put on housing, and the amount of time spent on housing. The share of the economy that's occupied by housing just is not helpful, it's not constructive and it contributes to Canada's poor productivity over time because too many resources. Even if we're contributing that right now, but that's what we do on podcasts.

Okay. I guess the bigger picture, you're saying the market probably firms through the course of the year. Things, price-wise, probably bottoming in the first half of the year at some point, whenever that is. BMO is expecting rate cuts from the Bank of Canada starting in June, which I think is really looking pretty good right now. As rates fall, prices probably firm up accordingly and keeping that affordability equation more or less static, as prices pick up a little bit with rates falling.

Moving to the bank a little bit here. Do you have any other takeaways last week, from the Bank of Canada? From my perspective, they're still focused on inflation, we're just not there yet and it's just time.

Robert Kavcic:

Yeah, it's the same. I think our call looks good, too. That June call is a little bit behind the market. I think you can agree or disagree, but I think our view coming into the year was the market got a little bit hopped up, pricing and rate cuts too early, and maybe too aggressively for 2024. The reality now is that, you said it, inflation is still not where the bank wants it to be. A lot of those core measures are still running with three handles, three month annualized. The growth numbers now, November, December, Q4, Q1, are actually holding in better than we thought.

Ben Reitzes:

Yeah.

Robert Kavcic:

The bank is looking at this and saying ... Okay, they've admitted they think policy is tight enough, but not for long enough yet. I think mid-year looks good.

Ben Reitzes:

Yeah. With the Fed looking more focused on where real rates are, rather than how the economy's performing, as PCE inflation comes down. Core PCE, the core PCE deflator trends around 2%. It looks like they're going to have the green light at some point in the next few months to cut, probably. I suspect the bank will, if they're smart, they'll use that to their advantage and wait a little bit longer. Watch the Canadian dollar strengthen, that'll help on the inflation front, and then you've done your job pretty well there. That means June, again, even in that scenario, looks pretty good generally. It wasn't, I don't think, an overly complicated Bank of Canada. At this point, it's just about time.

Yeah, this morning's GDP number was shockingly good. Not sure I believe it, that's how good it was. I'm never one to doubt the data. You get what you get, and you don't get upset. But the December flash was really strong, it would not shock me at all if that gets revised down a little bit. Lots of momentum. I guess, you did have housing come back in the month. Home sales rose a lot in December and rates fell decently, so maybe that sparked some activity. But, I don't know. We'll see if that's in any way sustainable or even real at the end of the day, once we get the final numbers. Some downward revisions wouldn't shock me here. It seems early for Canada to be rebounding at this point.

I have one more question on housing that I forgot to ask. We talk a lot about Toronto because we're here. I'm sure a great many people would tell us that it's not the center of the universe.

Robert Kavcic:

What? Well ...

Ben Reitzes:

What are you seeing in other major centers? Let's say Vancouver, Montreal, and then say broader East Coast? I want to say Nova Scotia and Halifax, but just say broader East Coast. If you want to work through each of those, I think that would be helpful. Just so it's not just a Toronto thing, because obviously we're more than that.

Robert Kavcic:

Yeah. No, that's fair. We're starting to see some pretty big differences now, too. Unlike early in the pandemic and coming out of it, where everybody went down in a liquid, and then everybody rallied when the bank was at zero. Across the board, across the segment, it didn't really matter. Now, we're starting to see some pretty good separation.

I would say, top of the list, you would have Calgary and parts of Atlantic Canada. Moncton, Halifax, names like that, where prices are at record highs. They're not running at a double-digit clip, but we're seeing a little bit of incremental price growth from record high levels. That would be top of the pack.

Ben Reitzes:

Is that based on strong population growth, just good inflows of people? Lots of people, demand, very simple demand and supply.

Robert Kavcic:

It's a ton of demand, and attractive valuations and affordability. Look at somewhere like Alberta. Proportionately, you're getting the international inflows pretty uniformly across the country. But in Alberta's case, they're pulling in another full percentage point, on top of population growth, from people moving in, most from Ontario.

Ben Reitzes:

You mean Ontario's not affordable so they're going elsewhere? Shocking.

Robert Kavcic:

Packing up and leaving, yeah. What's funny is in the past, you would hear anecdotes of people flying into Fort McMurray for work, and stuff like that, or to get a better paying job. But now, they're moving just for affordability. Out of Ontario and the GTA, into Calgary. Because the houses are cheap and the lifestyle's good. Anecdotally, you can sell out of Toronto, and take $1 million of equity, move to Calgary, live a beautiful life. You're seeing that in the numbers. It's like 50,000 people per year. That's supporting it.

Bottom of the list, I would say, would be Southern Ontario, outside core of the GTA. Those are the markets when we say markets in some places are down 30%, it would those markets. Areas like Barrie, Guelph, London, Windsor, some of those-

Ben Reitzes:

In cottage country.

Robert Kavcic:

Cottage country has been decimated.

Ben Reitzes:

If only I needed a cottage.

Robert Kavcic:

Yeah. That would be bottom of the list. There's not a lot of momentum there. They're starting to balance out a little bit, but those prices are still right on the floor.

Then, in between is most of those other markets. Vancouver, parts of BC would be in between. Montreal would be in between. That's basically how the landscape is.

Yeah. Even in some of those really hard hit markets, in the last three months or so as rates have come off and the mood has improved, you've seen some of those really deep sellers markets start to improve a little bit, where listings have come off a little bit and demand is coming back. I don't think you're going to see a huge price rebound in those markets that have been hard hit, but at least we're going to probably start to see a floor.

Ben Reitzes:

From that perspective, taking all that together, there will be some markets that are hanging in a bit better and perform a bit better. But overall, the national picture's still pretty uniform, it seems like. Improving ... Or bottoming I guess, through the middle of the year, and then improving in the back half. Then, relative basis, everyone will just move according to their relative performance.

Robert Kavcic:

The other split we should mention here is singles versus condos. Singles in the GTA have already tightened up quite a bit. You're already seeing a lot more activity. Everybody wants a single attached house, that's where the demographic is. We haven't built them for 20 years. It's the same story you and I have been selling for the last, I don't know, 10 years we've been doing this.

Ben Reitzes:

At least.

Robert Kavcic:

At least.

Ben Reitzes:

Everybody can't have a backyard and a white picket fence. Oh wait, there's just not that many houses.

Robert Kavcic:

Believe it or not, everybody does in fact want a backyard and space when you're having two or three kids. That whole narrative that we're going to live in condos in the city, it's not what people want.

Ben Reitzes:

It's not what I want.

Robert Kavcic:

The flip side of that is all that condo supply that we talked about, some of that is going to spill onto the resale market that's coming down the pipeline. That's going to probably exaggerate that price gap between singles and condos even further, as we go through the next year or two.

Ben Reitzes:

That'll be interesting. That'll be something to watch in whatever year, 2025 or 2026, when we get more of those condos coming online and you get a bit more of that, I guess, supply skew towards condos versus houses. Maybe people do change their preferences, just based on prices, if that price gap moves enough. If you don't have, whatever, two, three, four, five million bucks to buy a house, and you have 600,000 to buy a condo, well maybe your mind changes then.

Robert Kavcic:

Yeah. It'll be out of necessity.

Ben Reitzes:

Yes.

Robert Kavcic:

Not because don't want a backyard. There's always going to be a bid there.

Ben Reitzes:

Financial pressures are very powerful. Financial incentives are very powerful, I think.

All right, I think that covers housing and the bank is pretty straightforward here. Why don't we conclude with the provinces? It is almost February. January 31st here, as we're recording. Provincial budget season, it starts in three weeks. We get BC in late Feb. We'll see who else comes out ahead of year-end. I assume we'll get most everybody by the end of March. Are there any broad themes that you're expecting? Things looking good, things looking bad, how are provincial finances shaping up at this point in time?

Robert Kavcic:

I think we're looking pretty good. I would say the biggest theme would be that we've transitioned from this environment where ... Remember, the last two fiscal years or so, where every province was coming in every fiscal update better, and better, and better than expected. The provinces had this huge revenue tailwind, relative to what they had expected. Some of them were setting the bar low intentionally, I think. We won't name names, but it starts with an O.

We're transitioning now, where ... Last budget season a year ago, a lot of provinces built in a really weak economic outlook for 2023 and it didn't quite materialize. 2024 growth is looking a little bit softer. They didn't get it wrong, they just got the timing off a little bit. 2023 came in way better, 2024 is probably going to come in, I don't want to say worse than expected because the numbers we're seeing come in at the end of 2023 are actually suggesting that growth is going to hold up relatively well, but probably more in line with expectations.

All that to say the big revenue upside surprises are probably behind us. Inflation has slowed too, and that's been a big revenue driver as well.

Ben Reitzes:

Yeah. When nominal growth slows, tax revenue slow with them. From my seat, I think things won't be nearly as bad as I thought they were, or were going to be, given that growth is holding in way better than expected here. If we don't see things really slow down further in the first half of the year ... I'm looking at the US as much as I'm looking at Canada, just the knock on effects there. The US hangs in well and gets anything close to the growth that we've seen for the past couple quarters, Canada probably doesn't weaken off all that much at the end of the day. That means tax revenue's probably hanging in there. We'll see where things end up. You may not need quite as much issuance as feared, call it six weeks ago or so, when it looked as though the economy was going to more or less flat for, I don't know, three to four quarters consecutively. Things are looking a little bit better now, which definitely helps. Those percentage points on GDP certainly help on the revenue side, generally.

Pecking order for provinces. Anyone in better shape than anybody else?

Robert Kavcic:

Just the other side of that last comment is on the spending side, too. A lot of provinces have a couple spending issues, let's say. The debt service costs are pretty straightforward, those are pushing higher. Even on the public sector wage bill side, a lot of contracts that were set pre-COVID with very slow growth rates are now rolling into an environment where we've had a couple years of big inflation, so they're getting set a lot higher. You're seeing labor unrest and some pretty big settlements in areas like Quebec recently.

Ben Reitzes:

They're negotiating right now there, still.

Robert Kavcic:

Yeah. That's going to put some pressure on, going forward. You're right, overall the balance is still pretty good because the economy's holding up. Budget balances should hold in relatively well. I would just flag those as a few areas of risk.

We have a few elections coming up this year. The bigger election calendar would be 2025, where you get the Ontarios and the Quebecs, I believe, along with the Federal government. But this year, we get BC as one of the big elections to watch. So some spending pressure coming there.

Pecking order? I still like Alberta. Fundamentally, the economy is 10 shoulders above the rest of the country.

Ben Reitzes:

It's hard not to.

Robert Kavcic:

$75 oil, that's right on their midterm fiscal protections, so they're still bringing in good revenues there, with oil up, dollar down. It's still a great story there. Even from a spread perspective, they look pretty good relative to somebody like British Columbia, where I would argue fiscally, they're in a tougher spot. Mostly because of political spending pressure and borrowing pressure in BC.

Ben Reitzes:

How about Ontario versus Quebec?

Robert Kavcic:

They trade pretty well in line. I would view them both pretty well in line as well, just based on just straight-up fiscal metrics. If you're looking at deficits, debt, debt service cost relative to GDP or relative to revenue, they're both pretty well in line.

I'd say Quebec was a great story for a number of years. They've stepped back a little bit because they've been spending more and succumbing to some of the political pressure to do things, like just send out a few billion dollars’ worth of checks to Quebec households.

Ben Reitzes:

Inflation payments.

Robert Kavcic:

That came straight out of the bottom line. Was it necessary? Probably not. Little things like that, they've not really put stress on Quebec's books, but they've downgraded them in my mind a little bit, just the way they're not prioritizing fiscal consolidation as much as they were in the past.

Ben Reitzes:

Okay.

Robert Kavcic:

Ontario looks pretty good. I would say they have a pretty good opportunity to lock in some credit rating upgrades here if they want to. If they want to come out with a strong budget in the spring, they're probably right there to do so. I think they're starting to pre-borrow already too, for next year, so that's helpful.

Ben Reitzes:

Okay.

Robert Kavcic:

When market conditions are good right now.

Ben Reitzes:

Okay. I think that's everybody. There's some smaller guys we haven't mentioned, but I'm going to have Rob back, probably either late in the budget season or just after the budget season. I'll rope in Jordan Sugar, our provincial trader, and we'll get a fundamental and market view on the provincial space at the same time. I think that'll be very topical of the time.

Rob, thanks for coming on this week. I appreciate your views. Again, I will have you on within the next few months. Thanks.

Robert Kavcic:

Sure thing. Thank you, Ben.

Ben Reitzes:

Thanks for listening to Views From the North, a Canadian rates and macro podcast. I hope you'll join me again for another episode.

Speaker 4:

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