Predicting the future: Real Estate Prices.
There are three main factors that explain this inflation in housing prices: population growth, wealth distribution and flow of money.
In large metropolitan cities such as Toronto, Vancouver, New York, Paris, London, Hong Kong, Los Angeles…and the list goes on, there is a tendency for population growth driven by internal and external displacements.
Internal displacements are mainly due to the disappearing of manufacturing activities in rural areas, replaced by technology and services oriented jobs and companies whose main offices are located in large cities. Therefore, people are fleeing the rural areas in droves to live in the vicinity of large cities to find work and what is perceived as a better life.
External displacement is mainly due to globalization and immigration. Some people relocate due to the nature of their jobs, and others due to external factors such as economic issues in their home countries where they can’t find opportunities or instability created by geopolitics.
These displacements have spurred the growth in vertical constructions and inflated housing prices around the large metropolitan cities.
In cities such as Paris and London, in order to protect the singularity of the architecture, regulations have been enacted forbidding the building of large apartment building through a vertical limit of how tall a tower or building can be, and that had the tendency to push the prices to extremely high levels, attracting only the richest of the richest.
The most common factors with cities with the highest real estate prices is a physical limit to construction created by the size of land available such as New York, Vancouver and Hong Kong, the regulations of the city forbidding vertical construction such as Paris and London; you also tend to find in those cities the wealthiest individuals from all ethnic backgrounds.
With a very skewed wealth distribution, it is not surprising to see that the large metropolitan cities where there are the wealthiest, tend to also have the highest prices. The people of modest means being priced out of the city centers toward the outskirts. This creates a ripple effect whereby the farthest you are from a city, the more likely you can afford housing if you are of modest means.
Now in Canada, we have a massive concentration of mortgage loans in the balance sheets of the 5 banks sharing that market. The Canadian Mortgage and Housing Corporation (CMHC) acts as a downside cushion in case the market drops up to 20%. The two Canadian cities with the most increase in real estate prices have been Toronto and Vancouver. The average detached house in Vancouver has been growing by 28% on average in the last 10 years according to Real Estate Board of Greater Vancouver. The city of Toronto has a year over year increase of 17% for a single detached from July 2016 Toronto Real Estate Board numbers.
The level of shorts in place currently on bank stocks is unprecedented as hedge funds managers are betting against the banks being able to sustain the mortgages loans on their books when you have the average Canadian household owing about twice their income and continuing to run with those line of credits and debts. (as of the first three months of 2016, the ratio of household credit market debt to disposable income is at 165% according to statistics Canada)
Source: TMX Money
At BlueSky Investment Counsel, we hold the view that the housing prices are not only being held to these levels by regular Canadian households but also by a constant influx of money coming through the channels of immigration and foreign investments. The 15% tax on foreign buyers in Vancouver will not be able to withstand the growth of prices in a very demanded, geographically limited piece of land in the long term, although we have seen a limited correction in the sales volumes recently. Toronto is in a similar scenario although its geographical size is offsetting some of that upward pressure in prices.
To withstand the low interest rate pressure and the impact of low oil prices* there have been a refocusing of the banks toward cutting cost, increasing their wealth management profits and looking outside of Canada for potential acquisitions…it is our view at BlueSky that they will somewhat succeed. In the meantime, they are kicking the can by postponing and buying time to cleaning up the Canadian loans but making it harder to borrow. And as some of the mortgages mature, their books become less risky. The intended goal being to manufacture a soft landing in the prices and to avoid a steep and rapid correction as this would have detrimental effects to the economy, similar perhaps to the United States in 2008. With this strategy, the growth will still continue because of many factors, some of which we already discussed. Other factors include the diversification of the Canadian industries to limit the impact of the oil industry on the Canadian GDP, the Bank of Canada keeping the interest rates at current levels and the potential success of the Canadian banks in finding other alternative ways to generate growth for their shareholders such as cutting cost, acquisitions and focusing in lines of businesses with a good growth potential such as wealth management (They can achieve this by supporting the Baby Boomers as they will be inheriting a massive 750 billions within the next 10 years, according to CIBC.)
For investors looking to diversify their investment portfolios and do not have the required 20% required by the CMHC not to pay mortgage insurance, you can still have direct access to real estate through REITs or Real Estate Investment Trusts. These are buildings bought by a company on behalf of investor; the company then rents it out and distributes the income, after taking its management fee, to the unit holders (Equivalent to shareholders). Just make sure to choose REITs with a good cash flow, high occupancy rate and located in Large Metropolitan areas.
REITs tend to pay an income upward of 6% but you pay full taxes on them, so better to own them in tax sheltered vehicles such as registered or corporate accounts.
* The banks still have large at-risk loans associated with oil companies in their books, although the recent recovery of oil prices has alleviated some of the concerns of the shareholders
Stats Canada, TMX, US Census Bureau, CIBC