DECEMBER 16, 2011
Here's a great reader comment that I've actually recently been doing some work on:
"Vacancies were flat in Toronto until 1990, and flat in Miami until 2007, and I think I saw a few more examples (haven't gone after Vancouver's past data yet). But you would think that if there was oversupply as part of a boom, that vacancies would go up before the crash in prices hit."
It's a great point. In most large cities in Canada, vacancy rates are benign (Toronto, Vancouver, Montreal, Ottawa) or are falling from elevated levels (Calgary, Edmonton). It's also a great point that in most large US cities, vacancy rates really took off AFTER that bust was well underway. The rate was 2.9% in Miami and 2.7% in San Diego in 2005. Today Miami's vacancy rate is 8.4% while San Diego's is now 6.7%.
Before discussing why I think vacancy rates in Canadian cities are as much a lagging indicator as anything else, let's review some extremely pertinent information that frames this discussion.
In the past decade, all provinces have built significantly more residential dwelling than demographic demand would warrant...and at a time when house prices have been very strong....a bit of a paradox if we act like traditional economists and assume that consumer behaviour remains constant over time.
Indeed, we've seen the population/residential dwelling ratio fall to new all-time lows. While this is certainly not a new story (it's been falling since the 60s), it will reach a concrete lower boundary.
Conventional thinking would assume that if you build more homes than people need, it must pressure house prices and/or raise vacancy rates. But once again, conventional thinking fails to take into account the massive shift in consumer behaviour over time.
There are several factors that I would argue play a significant, if unquantifiable role in hiding this mystery ‘inventory’:
1) Speculation: We’ve seen widespread speculation in markets like Toronto (particularly the condo market where 25% of all new units are being sold to flippers and 60-80% to cash flow negative investors) and Vancouver (where a municipal election candidate recently wrote of her experience canvassing in areas where virtually every house on a block is unoccupied).
2) The willingness of consumers to hold vacation homes that for all intents and purposes could be residential dwellings: In its 2009 recreational property report, Royal LePage Real Estate Services noted that, “64 per cent of Canadians view cottage ownership as a sound investment. To pursue their dream of buying a recreational property, 55 per cent of Canadians would be willing to make compromises with regards to their financial or lifestyle choices, such as purchasing a property with family and friends, renting out their cottage, making a cottage their primary residence, buying a fixer-upper, or moving into a smaller principal home in the city.”
While people are quite happy owning multiple homes during a housing boom when bullish sentiment is rampant and economic growth is strong, these properties tend to hit the market first when the boom ends or the economy sours. I'm currently digging into tax data to see how I can further quantify this, but the initial evidence suggests that the growth in vacation homes has been very significant over the past decade.
3) Change in household formation patterns: During housing booms associated with cheap and readily-available credit, there is an increase in households that are formed when children move directly from their parents’ home into a residence of their own, without renting. This is facilitated by the loosening of underwriting standards, a trend we’ve noted in Canada. Yet all our data strongly suggests that the economy is not nearly as sound as it appears on the surface. And when the recession finally arrives, these same individuals may find it difficult to make ends meet, opting instead to move back home. One needs to look no further than the US experience to see how household formation patterns accelerate during a boom and decelerate during a bust, in part because of this very dynamic.
The main point is that vacancy rates can remain low even while starts outpace demographic demand due to changing mass psychology. And while the vacancy rate may appear benign, other data points suggest that a potentially significant inventory overhang will likely appear if the real estate market begins to melt and the economy sours with it.