Has Housing Bottomed? - 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 Has Housing Bottomed?

I'm Ben Reitzes and welcome to Views from the North. Each episode I will be joined by members of be BMO's FICC Sales and Trading desk to bring you perspectives on the Canadian rates market and the macroeconomy. 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.reitzes@bmo.com. Your input is valued and greatly appreciated.

Rob, welcome to the show. It's, I guess, somewhat special edition. I recorded one last week, so two weeks in a row for me, which does not happen often. But since I'm not going to be here in a couple weeks, I figured it's a good time to do it with the Bank of Canada next week. And I think our listeners will very much want to hear about housing because that is always the most exciting and talked about topic in Canada for whatever reason. So welcome to the show.

Robert Kavcic:

Thank you, sir. Thanks for having me.

Ben Reitzes:

So where are we now I guess in the housing market? We've had an extended bout of weakness. Why don't we start with the title question, has housing bottomed? What are your thoughts there?

Robert Kavcic:

Well, depends where you are in the country. I think there are pretty clearly signs that some markets have bottomed out. We're seeing it in sales volumes. We're seeing some evidence in prices too. We just got Toronto numbers for March a couple hours ago and it looks like the market here is balanced out pretty quickly, just within the space of two months or so. We've gone from a pretty deep buyer's market to one that looks pretty balanced now. And then, so you asked what's happening there, have sales stormed back? Not really. They haven't. They're still kind of bouncing around these cycle lows, but listings have really come down and we're not seeing a lot of new listing flow.

Ben Reitzes:

Okay, so it's difficult to read that necessarily as positive. I guess the balance part is good. The fact that sales are still close to the lows is not overly encouraging, but nonetheless, I mean the fact that you're in a more balanced market means prices probably stopped pulling back. That in turn brings people in. Does that drive some buying interest do you think?

Robert Kavcic:

At the margin, I think. The market is still just not clearing very well. So you still have the situation where on the buy side you have buyers out there who want a house, physically there's a lot of demographic demand for housing in this country. We know that, right? But buyers can't qualify or pay for prices that existed six to 12 months ago at 4.5 to 5% mortgage rates. They just can't. But on the flip side of that, sellers are sitting there, "Okay, well, I don't want to sell into a market that's 20% down. There's nothing that's forcing me to do so." So the market's just not clearing. There's a big bid-ask spread, so to speak, in the market.

And so I guess what we're seeing now is just within the last two months or so, the Bank of Canada's come out and said we're done raising rates. That's helped confidence a bit. And we have actually seen those five-year fixed rates back off pretty significantly. We're down around probably 4.75-ish for a five-year fix, which, I mean, it's obviously still a lot higher than we were one or two years ago and we were taking out mortgages at 1.5. But incrementally, the news flow from a psychological perspective has been pretty decent the last two months if you're a buyer.

Ben Reitzes:

So we're more or less it seems at a stalemate for now, waiting for prices to fall or rates to fall and prices don't look like they're going to fall given the new balance to the market and the fact that there is no forced selling, which I don't think is shocking at this point. So rates have to fall.

And I mean, we've seen the rates market rally pretty materially in the past week or so. I guess, if we don't see rates back off and there's been so much volatility, I mean tomorrow we could be 20 beeps higher or maybe by Friday depending on what jobs do, mortgage rates probably should start to come down a little bit. I mean, 4.75, 4.80, whatever, is still pretty spicy. I don't want to pay that personally. Something's got to give. Neither side's willing at this point, which only pretty much leads the Bank of Canada or the rate market. That a fair assessment?

Robert Kavcic:

So what's going to break first in the standoff, I guess, is the question. So on the demand side, the bank has done raising rates, but if we start to get rate cuts in the second half of this year, why are we getting those rate cuts? Is it because the economy is really cracked and we start to see some job loss? Well, that's not going to help the demand side. Typically, you'd see the demand response coming out the next cycle when rates are down and the economy is starting to pick up again. So that wouldn't be a story for the second half of this year I don't think.

And then on the supply side, what's going to bring listings to the market? Because sales activity is still low enough that if we were getting significant listings flow, this correction would run on pretty deeper. What's going to bring more listings to the market? Job loss? I mean, typically from a housing cycle perspective, yes, but right now it's the opposite. We have still an extremely tight job market here.

So that's not it. And then look at what's happening on the rate side. So part of the reason behind this correction obviously is that we've seen the big reset higher in mortgage rates, but if you're somebody that took out 1.5% variable, yes your rate is risen significantly, but there's not a lot of payment stress because the vast majority of those variable rate mortgage holders aren't actually seeing their payment increase in real time. So from that perspective, there's not a lot of payment stress that's putting houses onto the market.

And if you're an investor sitting there probably saying, "Okay, well, the situation's not great right now. I don't want to sell 20% off the high. Well, I have a very tight rental market to lean back onto, and I can just kind of ride through the cycle that way because the rental market is so tight."

That's the question, which one of those is going to break first? I don't see a lot of reason to think a lot of supply is going to flood on the market, but at the same time it's kind of hard to see just an immediate snap back in demand too. So we might kind of stagnant here for a while.

Ben Reitzes:

And just kind of bounce along the bottom. That I can believe. If demand stays soft and supply also stays relatively subdued and we stay close to where we are now, that probably means prices have further to follow.

Robert Kavcic:

Yeah, I think so. It depends where you are. It starts to get more local now. So core, single, detached in somewhere like Toronto, we've already seen a bid come in there. That's not as rate-sensitive and it's obviously a premium area. But some other areas that were exploding through the pandemic, two or three hours outside the core of the big cities, those markets are down 20, 30% and they're still falling.

Ben Reitzes:

As they should be.

Robert Kavcic:

As they should be. Exactly.

Ben Reitzes:

That bid never made any sense to me. All right, so, I guess, decelerating national price declines. So we're kind of seemingly nearing the bottom on prices I would assume at some point this year, second half at some point is probably reasonable. Sale is probably bottoming. I guess the risk would be that, as you mentioned, weaker economy, job losses. And that is very much a realistic possibility given the way the economy's unfolding. And the Canadian economy and the US economy have been much more resilient thus far this year, but the data have been slowing generally. The US data this week have been uniformly bad. We'll get jobs for Canada on Thursday, but we're not expecting anything gangbusters. And so not looking for big job losses anytime soon either, but that could be one area where we get, see a little bit of stress.

The flip side though is even if we do see some job losses, the immigration that we're getting into the country is going to provide an underlying bid forever, or at least until it stops. I was going to say that job growth, we're only expecting 15,000 and that won't be enough to keep up with labor force growth given where immigration is. But that rolls back into housing where you get that kind of population growth, that kind of immigration, all those people need to live somewhere. And as much as they're not coming in and buying $3 million houses, still got to go somewhere and that still puts a bit in one level after the next of housing. So the underlying support still there I think in a medium term. I think I'm bullish- ish. Do you share that view?

Robert Kavcic:

I do. We've been bullish on the demographics here forever going back 10 or 15 years. So what we actually have is you have peak domestic demographic demand right now, almost literally right now. The millennial cohorts, 32, 33 at the peak right now. So they're having kids, they're looking for houses. That's going to continue still for another five-plus years. We get maybe past peak stress, but there's still a pretty big chunk of that cohort moving through. And then you're layering on 500,000 per year from outside the country. So you're taking max demographic stress and you're amplifying it and making it even worse.

Ben Reitzes:

Sounds like great policy.

Robert Kavcic:

The timing is not ideal. But yeah, so from a housing perspective, we come through the back end of this cycle and after we've kind of adjusted everything from an asset price perspective, and the fact that we're probably going to actually see construction fall this year rather than double as policymakers are pushing for, you come out of this cycle into the next one and you're kind of back in the same situation that we started in, which was this kind of chronic undersupply because we just have such demographic strength. And once we've cleaned all that froth out of the market, then prices kind of find a floor and start pushing higher again.

Ben Reitzes:

Well, and that begs the question, why don't we just build more?

Robert Kavcic:

Yeah, it's so easy, just double the rate of construction for the next 10 years. From the minute the federal budget was published last year, we've pretty much said there's absolutely no chance this is going to happen. Maybe it's the right thing to do and maybe the arithmetic makes sense, but there's physically no way we can possibly double the rate of housing construction. We know this, right?

You have record-high vacancies in construction as it is, you have a near record-low unemployment rate, you have just, I mean, skill shortages across trades, and you have already on the ground today the most housing under construction that we've ever seen in this country and in per capita terms, we have the most that we've seen since the late 70s building boom. So we're already building full out as much as we can. To think we can just double this, is just, it's nonsense. It's not going to happen.

Ben Reitzes:

Every immigrant that we bring in the country should just go right into construction. They can build their own houses, everyone will be happy.

Robert Kavcic:

Yeah. See, and the problem here is, okay, we bring in 500,000 people per year because we need the skilled labor, which is true, yes we do, but it takes time to integrate everybody into the labor force and actually have them out there producing. But the minute they walk into this country, they need a place to live and they need a doctor and they need other infrastructure and services. So over 10, 20 years, yes, fine, it makes sense from a policy perspective, but today it's just exacerbating the problem that's already on the ground.

Ben Reitzes:

Couldn't agree more. I'm not really sure how to solve that one, but we'll have to wait and see how things evolve there.

So I guess, bigger picture, housing looks like it's probably at least along the bottom. So calling the bottom I think is kind of a mug's game because you really never know what's next, but probably bouncing on the bottom for sales. Supply does not look like it's going to pick up materially, so that keeps prices more or less in line. There's decelerating decline in prices. We're not expecting a boom anytime soon, but a little more balanced there. And the market will look better, maybe not 12 months from now per se. It'll probably start to look up by then. But 24 months from now, things should look much healthier.

Robert Kavcic:

Yeah. And there's a lot of nuance to this too. There are some pockets, say if you look at the pre-con condo market that has been primarily investor bought and a lot of that's going to be coming to completion over the next two years. And depending where rates are and depending what the economic situation is at completion, a lot of those buyers never intended to take possession anyway. And those that did, maybe the economics of having a rental property at 1.5% mortgage rates were realistic. But if they're taking possession of those units at 4 or 5, doesn't make any sense anymore.

Ben Reitzes:

Well, maybe. It depends. We'll see what rent does because rent's been picking up pretty substantially. I would expect that continues. As rates stay higher, I think rent just continues to rock higher. It might not be as uneconomical as it seemed maybe a year ago if rates were to go up just because rent has really moved. So I mean, we'll see on that front. If it's far enough away, if it was right now, it's a different story. But I don't know, a year from now you get another year of rental growth at 6, 7, 8%, maybe it's close, it might be close, at least. Better than it looked a while ago when you were carrying negative through most of the low-rate days.

Robert Kavcic:

Yeah. And if we're back down to 3 or 4% of mortgage rates, that's a lot different than 5.

Ben Reitzes:

That's, I think, a year from now and we could very well be there. Our official call is for rate cuts at the start of next year and it's very plausible that could get pulled forward to the fourth quarter or something like that depending on how inflation and the economy evolve. And right now it's looking like softer, but long way to go between now and then.

Well, it looks like the bottoming in housing appears to have been, to some extent at least driven by the Bank of Canada. And they told us in January that they were likely to pause and they did so in March and we expect them to do so again next week. Where do you see the bank going with policy? I mean, are we on hold indefinitely? Is that going to embolden people to borrow more at the end of the day?

Robert Kavcic:

Well, yeah, we see them on hold through the rest of this year. And maybe there is some chance that we see rate cuts creeping in later this year. It's not the call yet, but that's probably where the risk lies, right?

This is very simple. From a housing perspective, this is very simple. The bank cut rates to basically zero. The housing market rallied. The bank said they're going to keep them here for a really long time and the market went parabolic. Then the bank comes out and taps the brake with that first 25 basis point rate hike and the market went dead overnight. And then we've worked through a 20% correction. The bank comes out and says we're done raising rates, and all of a sudden the market firms up immediately. This is not complicated.

Ben Reitzes:

The bank matters, I guess, is pretty much the simple way to put it for housing in particular. And as their signals go, so we'll go the housing marketing. And so I guess as long as they stay on hold, that will embolden some to borrow more. And then eventually when we do get those rate cuts, you'll see that housing side pickup. We're not expecting anything for next week. I think things are evolving almost exactly as the Bank of Canada would like to see it.

The Business Outlook Survey weakened. It wasn't terrible, but it weakened, pointing to softer growth ahead, slower inflation expectations, slower sales growth, less employment stress, less capacity pressures, kind of everything you really want to see. I think they're probably smiling after that survey. The downside is that some of the harder data has been pretty good so far this year, but if the boss is any indication, we'll see some slowdown there.

And the timing looks as good as could be also for the bank with the US banking stress coming into play and they look pretty good. Sometimes better lucky than good. I'm pretty sure they didn't forecast the US banking stress. And while the Fed probably goes a little bit more, the bank looks like they're pretty comfortable here. I think that largely sums up the bank.

Changing gears, what were the big takeaways, and it can be one or two because I know that things weren't overly exciting, but what were the big takeaways from the provincial budget scene this year? As high level as you want because, again, it wasn't that exciting. The federal budget wasn't exciting either unfortunately, or fortunately, depending on your perspective.

Robert Kavcic:

Still managed to write five pages on the very unexciting federal budget. But no, so provincial budget season, I think there really wasn't too much going on there. So big themes I would say, one is that there was not a lot of impetus to roll out fiscal stimulus or new spending measures at the provincial level. Some provinces did, like BC is pretty spending happy right now and borrowing quite a bit for capital spending and stuff like that. So BC actually has a very big borrowing program twice what they've been used to seeing over the last five years. Couple others cut personal income taxes a bit, which was interesting. Quebec and New Brunswick did that.

Ben Reitzes:

Those are relatively high-tax jurisdictions, though.

Robert Kavcic:

They're high-tax jurisdictions, yeah. But it's funny because we're in this world now where biggest issues households are facing here politically or economically are affordability and labor supply. So these provinces are saying, "Well look, we're relatively high-tax jurisdictions. What if we actually cut income taxes?" It helps affordability and over the long term, maybe it draws in more labor supply. It's probably a lot better policy than just giving somebody a $500 check, right?

Ben Reitzes:

Yep.

Robert Kavcic:

So I mean, that's up for debate.

Ben Reitzes:

Nope, it's not. Not here, not on my podcast it's not.

Robert Kavcic:

Okay, good. But I mean, that was it. And if that kind of starts a bit of a tit-for-tat response at the provincial level, that's probably a good thing for us in this country from a policy perspective.

Ben Reitzes:

Can't hurt our productivity, which has been absolutely dismal forever. Maybe it does something on that front because we've been pretty much a decade with taxes and going in one direction.

Robert Kavcic:

And Ontario actually in their budget too, they threw in a line there that said we're going to review the tax system as well. They didn't hint whether it was going to be up or down, but based on the platform of the current government, you would think that the direction is down. But anyway, there's more to see on that.

The other theme I would say is that we've come off two years where provinces were constantly coming in better than expected, mostly because of economic growth and inflation being stronger than expected. I think that world, and we already talked about this probably last time we did this podcast or over the last year and some of the written work we've done, but that world is probably behind us now because the economy's slowing and expectations at the provincial level from an economic perspective have more or less been reset to reality.

Ben Reitzes:

And GDP inflation won't be 8% in the coming year or the year after that hopefully. So that definitely dampens revenue growth materially.

I think Ontario might be the biggest story out of all this in that their numbers have finally caught up with what we knew and what they would never really tell us in the budget or the update, that revenues are growing really, really strongly and the deficit will not be nearly as large as what they've said, but they kind of stuck with that for a long time. And now we're looking at a relatively small deficit in line with Quebec. Debt's in line with Quebec now, net debt. Ontario, Quebec spreads are pretty much in line now after Quebec traded through Ontario for some time.

And I mean, I guess until we see a political change or some other budget change, is there any reason to think that those spreads, Quebec or Ontario, either one, will outperform the other?

Robert Kavcic:

No, I think to your point, they've been trying to sell us $15 to $30 billion deficits for the last two years, and we've seen anything from a $2 billion surplus to a $2 billion deficit, which is basically nothing, is rounding error. So balanced budgets for basically three years here. Again, I mean, I guess that's priced into the market.

So Quebec, I would say, has been a little bit more willing to roll out spending and tax relief. So, from a fiscal perspective, they've allowed themselves to backslide a little bit. I mean, to be fair, they just came off an election too, so a lot of money was pushed out through inflation support programs and stuff, i.e. sending people checks right around the election. So conceivably that is behind us now, so they can maybe settle back into what's been normal for Quebec, which is pretty sound fiscal management, I would say.

Ben Reitzes:

They've been great the past 10-plus years. I mean, big shift from the prior couple of decades. So that's almost why I think Ontario is the bigger, because Ontario has taken a big step in the right direction over the past three years. Before that it was kind of chronic deficits for a while and moving in the wrong direction while Quebec was always getting better and now same place more or less.

Robert Kavcic:

Yeah. They seem to be settling in at the same place. I would say one name that's moving the other direction is BC now. They're pretty clearly really for whatever reason focused on running deficits at whatever cost.

Ben Reitzes:

And straining finances from that perspective.

Robert Kavcic:

And spreads, I think spreads relative to Ontario have, I think probably trading right in line with Ontario right now, aren't they?

Ben Reitzes:

Slightly through, depending on where you are, but not where they were pre-budget and not where they have been over the past few years. It's not as rosy a fiscal story as it was. But the growth dynamics are still there for the province so that is a pretty big silver lining. Long as that remains intact, they should probably be okay, but the risk is clearly there and things are not quite as good as they once were.

Robert Kavcic:

Yeah, And then keep in mind too, Ontario and Quebec still have twice the debt burden as BC. So yes, the momentum is not in their favor, but they have a long way to go still.

Ben Reitzes:

So Rob, coming close to the end here. As an investor, what are the top three provinces you'd want to own here?

Robert Kavcic:

Well, so, I guess, considering the market environment and where we are in the cycle and maybe more uncertainty, more volatility going forward over let's say the next year or so, Ontario, Quebec, just because of the liquidity in those names. I mean, that's pretty straightforward right there. But also the fact that we are basically running budget balances, balanced budgets in those two provinces. And as we've said, Ontario has come pretty long way. So I think both of those names are in pretty good shape.

Alberta as well. They've obviously pushed out a lot of spending too. They were running huge surpluses last year. But oil prices are down a bit. They have some pre-election spending demands, which are now on the books too. So that's another name that still looks pretty good. There's a little bit of uncertainty about what actually happens post-election later this spring because you remember last time the NDP moved into Alberta, the fiscal situation after that election didn't evolve very favorably from the perspective of an investor. So there's a bit of risk on that one still, but I think fundamentally from an economic and a resource price perspective, they look pretty good.

Saskatchewan too. It's a small and not very liquid name, but they kind of piggyback Alberta. And they actually posted a very sound budget and they're not borrowing much at all this year. So that province still looks pretty good too.

Ben Reitzes:

I would agree with most of that. I think if you are expecting a recession or downside for markets generally or risk assets, then Ontario, Quebec are probably the safe way to go near term. And as things then pick up, I'm still medium-term bullish on oil. That's not going to change for me. Then Alberta looks probably pretty good, especially if you see any further widening from here because they already do look relatively cheap to Ontario, especially further out the curve.

Rob, thanks for coming on the show this week, and I apologize to you and the listeners for the Nintendo-like sounds coming from outside on the training floor. I'm not sure what that is, but someone's got some good sounds there. Rob, thanks for coming this week.

Robert Kavcic:

All right, thanks, Ben. Anytime.

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 3:

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