Monitoring mortgage credit demand....Will it give clues to the direction of the housing market?
JULY 24, 2011
Revisiting the driver of real estate growth in Canada:
It's no surprise to any reader of this blog that house prices in Canada over the past decade have significantly outpaced the traditional fundamental drivers of rental growth, income growth, GDP growth, and inflation. I don't want to kick a dead horse, but I also don't want new visitors to miss this key point.
On a national basis, the evidence is clear: We are significantly overvalued.
Yes, this has been pulled higher by exceptionally irrational behaviour in BC, but that glosses over the fact that fundamentals are also ugly in many other provinces and cities. We've discussed this at length:
Income growth: Cities and provinces
Inflation: Provinces
GDP growth: Provinces
We've seen that interest rates have had a significant role in this process, but that interest rates alone cannot explain the pronounced dislocation between house prices and fundamentals (check out the discussion at the end of this article).
We've also examined the silly argument that population growth is the driver of house prices increases in Canada. It's a convincing argument....until you look at the supply side.
Finally, we recently addressed the suggestion, which is gaining increasing media traction, that house prices in Canada are actually not that expensive....the average has been pulled higher by transactions in the $ million range. Interesting suggestion, but once again, the stats have something else to say. When we analyzed the Teranet index, an index that largely controls for the influence of 'average' house prices, we still found that house prices had significantly outpaced fundamentals.
So that leaves us focusing on graphs like this:
Yes, ladies and gentlemen, this is one housing market plumped by abundant credit coupled with willing borrowers...particularly over the past decade. It's the sort of mix that makes for a wild party, but leaves a heck of a hangover.
Indeed, the expansion in mortgage debt relative to GDP has been what has had the strongest relationship with real house price increases over the past decade. So let's take another look at it and see if it can possibly give us some hints on what comes next.
This first graph shows the year-over-year change in real (inflation adjusted) house prices over the past decade, compared to the year-over-year change in mortgage debt as a percentage of GDP. The relationship is clear.
It makes sense. We know from the work of Robert Shiller that house prices over long time horizons tend to pace inflation, meaning that the real return on housing is roughly zero. Other researchers have suggested that rental growth, per capita GDP growth, and income growth are also important variables that should drive house prices. The extent to which each variable is emphasized varies by researcher, but when house prices signifcantly outpace ALL of them, there is cause for concern.
With regards to inflation, it makes sense that real house prices should move higher primarily when mortgage debt as a percentage of GDP expands. House prices should roughly pace inflation. As inflation pushes up the costs of labour, land, and building supplies, the replacement costs rise, and so to do existing houses. But to rise significantly above inflationary pressures requires that people take on greater debt burdens relative to their incomes. And since GDP is just a measure of our collective income, as mortgage debt rises relative to GDP, it's just another way of saying that people are taking on more mortgage debt relative to their income. It's quite difficult to have sustained real house price increases that are not also associated with an underlying expansion in mortgage debt relative to incomes. That has clearly been the case in Canada.
While it appears that house prices lead the change in mortgage debt, I'll suggest that this is likely not the case. Sales are reported to CREA as soon as they happen. Any sale becomes part of the data set as soon as the papers are signed. However, mortgage debt is counted only after the deal closes, which often entails a gap of several months.
That being the case, we might expect that times where mortgage debt as a percentage of GDP is decelerating on a year-over-year basis, and especially when it is negative, it will exert downward price pressure on real house prices. On the flip side, as mortgage debt relative to GDP is accelerating and strongly positive on a year-over-year basis, we might expect house prices to experience upwards price pressure. Has this been the case? Generally it has.
Historically, the year-over-year change in mortgage debt as a percentage of GDP has been a fairly good, though not perfect, indicator of short term price movements in the Canadian real estate market. I believe this will be especially true going forward. The reality is that house prices cannot be sustained at current levels without a stable supply of new buyers with ample new credit able and willing to take the plunge. With ownership rates already stretched, and with prices at such high levels relative to incomes, it overwhelmingly argues that the deluge of first time buyers who have taken the plunge in the past few years, armed with ample mortgage debt courtesy of CMHC's accommodative policies, will NOT be around in sufficient numbers and have access to sufficient credit to keep the party going.
Of note, the year-over-year change in mortgage debt as a percentage of GDP has been exceptionally weak over the past two quarters...the weakest pace of expansion since 2000. With non-mortgage consumer credit already cooling rapidly, one can't help but wonder if the great Canadian consumer is ready to tap out. If so, this metric may give us an early warning. We'll revisit this one periodically.
Cheers,
Ben
Posted in:
- |
- Tagged:
14 Comments
Ben,
"With ownership rates already stretched ... accommodative policies, will be around in sufficient numbers ... "
Did you mean to say "... will NOT be around ... "?
Yup. Thanks...
There is something not right with the very first sentence - "It's no surprise to any reader of this blog that house prices in Canada over the past decade the traditional fundamental drivers of rental growth, income growth, GDP growth, and inflation." I am ESL but it feels that there is something missing there?
Thank you. Fixed. I sure made a mess of this one. I need to stop writing when I'm tired...
Time to introduce Canadian "Credit Accelerator" data to the readership. Will generate some interesting discussion.
"...the deluge of first time buyers who have taken the plunge in the past few years, armed with ample mortgage debt courtesy of CMHC's accommodative policies, will NOT be around in sufficient numbers and have access to sufficient credit to keep the party going."
I searched for data on first time buyer demand and how much has been brought forward recently. I found lots on how demographics will affect the supply of future sellers but couldn't find much on the other side of the equation, the supply of future buyers. It would be interesting to see how first time buyer numbers from the last few years compare to historical averages. That pendulum should be reversing its direction soon.
I did find the following from a past article on this site:
"According to the CMHC, 43% of households who purchased a residence in 2009 were first time buyers, up from 36% in 2008"
Unfortunately many of the future buyers are already $27,000 in debt.
http://www.theglobeandmail.com/news/opinions/opinion/the-crushing-weight...
I don't see much difference between $27000 @ 8% on $15/hr versus $450k @ 2% on $35/hr. Well actually I do. In the former case you can always go up.
And in the latter case interest rates can rise or you can get "downsized".
Debt is dangerous, and boy oh boy have we ever forgotten that as a society!
Ownership rates and what do they really mean? For example car ownership rates in the U.S. are currently 780 vehicles per 1,000 population, up from about 750 ten years ago. In contrast Canadian car ownership rates are only 563 vehicles per 1,000 people. In Italy there are more cell phones than there are people.
What does it mean? I don't know and I don't pretend to know.
What is so magical about the 70% homeownership threshold? Where did it come from? Why can't the level be higher?
Or is it just an arbitray historical figure that hasn't been surpassed before (like the sound barrier before Chuck Yeager) and is therefore deemed insurmountable by all of the "experts."
Newsflash, idiot....You can't have home ownership rates at 101%. There is an absolute threshold. Were you actually ever in this business? You strike me as being too dense....
I own five homes. Many people own vacation homes and / or cottages as well. Who's the idiot now?
YOU are! You don't have a clue how that figure is calculated. It's the percentage of households that own a home.....regardless of how many they own. 70% are owners of AT LEAST one home.
Like I said.....I can't believe you were in this industry. It says a lot for the standards in the industry when people like you are 'industry experts'. You continue to show a shocking ignorance of the facts. At least you are frequenting this site...You'll finally get an education.
You still haven't explained why the homeownership rate can't / shouldn't / won't rise above 70%? Which was the thrust of my argument.