Consumer Watch Canada

Transcription

1 Economics & Strategy Consumer Watch Canada April 18, 27 Jeffrey Rubin Avery Shenfeld Benjamin Tal Peter Buchanan Warren Lovely (41) (41) (41) (41) (41) Much Ado About Nothing: Canadian House Prices Not Based on Demographics Alone Benjamin Tal How real is the fear that real estate values in Canada will face downward pressures in the coming decades due to an aging population? Does the falling number of first time buyers and the downsizing and increased liquidations of houses by seniors mean an inevitable decline in house prices? The short answer is that those fears are highly exaggerated. Yes, all other things being equal, those forces will have a net negative impact on house prices. But, of course, not all other things are equal. Even a modest adjustment to the number of new housing starts in the upcoming housing market cycle will completely eliminate any demographically induced price decline. Instead of falling, house prices in Canada are more likely to double in the coming twenty years. Chart 1 Canadian House Prices A Full Cycle Perspective Nominal House Prices % chg Average Real House Prices % chg Average The Demographic Story Not Boom or Doom In the late 198s, a highly quoted paper named The Baby Boom, The Baby Bust, and The Housing Market famously predicted that given the American demographic landscape, real house prices would fall by 3% per year between 1987 and 27. Today, we know that US real house prices rose by almost 4% a year during that period. Similar concerns were raised in Canada, but the end result was a 3% annual increase in real home prices over the past twenty years, with the market correction of 199 being largely due to cyclical factors and monetary policy over-shooting (Chart 1). Were those predictions wrong or have they, in fact, already occurred and simply been masked by the surge in demand for housing due to other factors? The experience of the last real estate cycle provides us with a unique opportunity to tackle this question and assess the prospects for house prices in the next cycle. A quick glance at Chart 2 puts the demographic picture in perspective. The focus here should be on the difference in population growth between the two cycles ( and using Statistics Canada s medium growth, medium immigration projection as a benchmark). The chart clearly reveals the well documented expected slowing in the rate of growth in the age group and the notable acceleration in the pace of growth in the age group. Sources: CREA; CIBCWM CIBC World Markets Inc. PO Box 5, 11 Bay Street, BCE Place, Toronto Canada M5J 2S8 WGEC1 (41) CIBC World Markets Corp. 3 Madison Avenue, New York NY 117 (2) 85-4, (8)

2 CIBC World Markets Inc. Consumer Watch Canada - April 18, 27 Chart 2 The Demographic Story The Past and The Future Population Growth by Age Group mn < F Sources: Statistics Canada using medium growth, medium immigration projections; CIBCWM But from a housing price perspective, what counts is not only the change in population of a given age group, but more importantly, the level of housing market activity among those age groups. For example, the change in the number of Canadians age 25 and under is basically irrelevant from a housing demand perspective, since only a small proportion of individuals in this age group actually buy houses. Chart 3 Net Change in Population Growth The Next Cycle vs. The Past Cycle < mn Distribution of Housing Demand 4.1% 7.9% 11.8% 14.9% 1.4% Chart 3 presents information on the projected net change in population between the two cycles, alongside their respective share in total housing market demand. The key observation here is that the projected 17, net decline in the number of first time buyers (age 25-44) is marginal, at best. Note, however, that this age group is by far the largest contributor to overall housing demand, accounting for almost 8% of all home purchases at any given time. In other words, the group that is most likely to buy a house will see only a marginal change in its number compared to the previous cycle therefore not impacting net change in housing demand in any significant way. What about the other age groups? The largest decline (2.5 million) is projected for the age group 45-54, as many baby boomers move to the next age bracket. But note that this age group accounts for only % of total housing demand. And even that limited decline in housing demand will be partly offset by the strong increase in the age group and its surprisingly high housing market activity largely reflecting purchases of vacation and investment properties (Chart 4). So, when it comes to demand for housing in the upcoming cycle, the data does not support the big drop feared by many. But what about the supply of housing? After all, the aging population also means that a larger number of Canadians will start downsizing, as empty-nesters move to smaller houses and apartments and older Canadians sell their properties due to declining health and related difficulty in coping with the upkeep of their homes. Chart 4 Owning A Second Home % of all respondents in each age group < All Ages Own a vacation property/second home Own a rental investment property Source: Altus Clayton/Ipsos-Reid, The FIRM Residential Mortgage Survey, Sept 25 (Q.4) 2

3 CIBC World Markets Inc. Consumer Watch Canada - April 18, 27 Chart 5 Residential Mobility of Households Chart Housing Starts % of hholds moving at least once in previous yrs s Average 4 2 < Age of household maintainer Source: CMHC, adapted from Statistics Canada (Survey of Household Spending) Directionally, of course, these concerns are legitimate. But again, it is important to also assess the magnitude of this potential increase in supply. Chart 5 illustrates the propensity to move among Canadian households and naturally the propensity to move declines with age. Our main focus here, however, is on the age group (empty-nesters), and from the chart, we learn that on a regular basis less than one-third of those households actually move. What s more, this low proportion might be even lower in the coming twenty years as those baby boomers have more financial assets and are generally in better health than their parents. As for the age group 75+, a second look at Chart 3 suggests that the 5, net increase in the number compared to the previous cycle is not large enough to flood the housing market with extra supply, after converting this figure into the number of households. Putting all this information together (the potential reduction in demand among first time buyers and the extra supply due to downsizing and liquidation), we estimate that in the coming twenty years, the Canadian housing market will face extra supply of roughly 25, houses. While at first glance this appears to be a large number, it means an average extra supply of only,5 homes a year during that period. And considering that total housing starts (new supply) during the previous cycle averaged 18, per year (Chart ), the implications are that in the coming cycle, builders will have to reduce new supply to just under 17, to completely eliminate any negative demographic influence on house prices compared to the previous cycle. 1 5 Source: CMHC The downsizing by empty-nesters will clearly force builders to also adjust the composition of new homes more towards multi-units (mainly condominiums). But those who expect a significant rise in the price of condominiums in the coming twenty years will be disappointed. Even if we assume that a full one-third of Canadians age will move to multi-units (a very strong assumption), this means that, on an annual basis, builders will have to increase supply by 14, multi-units compared to the previous cycle in order to eliminate all the potential price impact of that extra demand not a tall order given the recent jump in condominium developments. Demographics Is Not Everything While homebuilders can easily offset any demographically induced risk to home prices, the necessary adjustment will end up probably being even smaller than suggested in the above discussion. Besides demographics, many factors will impact house prices in the coming twenty years. In contrast to the popular view, interest rates will not be one of them. Note that we have been operating in a low interest rate environment for the past decade or so reflecting a structural slowing in inflation (Chart 7). And the likelihood is that, on average, inflation will remain low in the foreseeable future due to many factors chief among them is the anti-inflationary nature of globalization. This means that, on average, future interest rates will not be significantly different than what we have witnessed over the past decade therefore providing a minor extra boost to housing demand.

4 CIBC World Markets Inc. Consumer Watch Canada - April 18, 27 Chart 7 Inflation and Interest Rates Chart 9 Non-Conforming Mortgages % Jan-5 Jan- Jan-7 Jan-8 Jan-9 Jan- 1-yr Govt of Canada Bond CPI inflation rate (y/y % chg) Sub-Prime Share in Mortgage Originations % US Canada Interest-Only Mortgages (US) % of originations Canada Given that two-thirds of population growth since 21 was due to immigration, it is clear that the pace of growth in immigration will be a major force that will impact housing demand. While for this analysis we used Statistics Canada s medium immigration projection as a benchmark, it is very likely that the actual pace of immigration growth will, in fact, be faster due to expected changes in immigration policies. However, note that from a housing market perspective, the increase in the number of immigrants will be partly offset by the ongoing decline in their propensity to own a house (Chart 8) which as of 21, was roughly in line with native-born Canadians. Another important potential driver will be the growing pace of mortgage innovation in the Canadian market. As illustrated in Chart 9, when it comes to mortgage products such as interest-only mortgages, extended amortizations and sub-prime, the Canadian market has been extremely conservative during the past housing cycle. While there is little doubt that the US lenders and borrowers push the envelope when it comes to using such products, in Canada, the process is only in its infancy. And since the starting point in Canada is so low, one can argue that there is some room for these products to grow without triggering a significant increase in the overall risk profile of the Canadian mortgage market. Such a process would introduce another level of dynamism to the Canadian market supporting housing demand and prices. Chart 8 The Immigration Picture Rising International Immigration s Falling Homeownership Ratio Among Immigrants 7 % Native born Immigrants The Bottom Line Few economic relationships are linear. Housing market activity in the coming 2 years will fluctuate and swing in both directions. Cyclical forces will continue to influence housing demand and prices in the near and medium term. But looking at the full cycle, our finding is that the widely held fear of a softening in housing market activity and structural downward pressure on prices due to the changing Canadian demographic landscape, are largely unsubstantiated. Our analysis suggests that when compared to the previous housing cycle, the projected demographic changes in the coming 2 years will not be large enough to dramatically alter housing market conditions and can be completely offset by a relatively small adjustment in the number of housing 4

5 CIBC World Markets Inc. Consumer Watch Canada - April 18, 27 starts. Accordingly, from a full cycle perspective, we project that the average real house price in the coming 2 years will mirror the performance of the past 2 years. And assuming a 2% annual inflation rate, this means that house prices in Canada, instead of falling, will in fact double by 22. This increase, of course, will not be symmetrical with large cities seeing even larger increases in home valuations. 5

6 CIBC World Markets Inc. Consumer Watch Canada - April 18, 27 Conflicts of Interest: CIBC World Markets analysts and economists are compensated from revenues generated by various CIBC World Markets businesses, including CIBC World Markets Investment Banking Department. CIBC World Markets may have a long or short position or deal as principal in the securities discussed herein, related securities or in options, futures or other derivative instruments based thereon. The reader should not rely solely on this report in evaluating whether or not to buy or sell the securities of the subject company. Legal Matters: This report is issued and approved for distribution by (i) in Canada by CIBC World Markets Inc., a member of the IDA and CIPF, (ii) in the UK, CIBC World Markets plc, which is regulated by the FSA, and (iii) in Australia, CIBC World Markets Australia Limited, a member of the Australian Stock Exchange and regulated by the ASIC (collectively, CIBC World Markets ). This report has not been reviewed or approved by CIBC World Markets Corp., a member of the NYSE and SIPC, and is intended for distribution in the United States only to Major Institutional Investors (as such term is defined in SEC Rule a- and Section of the Securities Act of 1934, as amended). This document and any information contained herein are not intended for the use of private investors in the UK. The comments and views expressed in this document are meant for the general interests of clients of CIBC World Markets Australia Limited. This report is provided for informational purposes only. This report does not take into account the investment objectives, financial situation or specific needs of any particular client of CIBC World Markets Inc. Before making an investment decision on the basis of any information contained in this report, the recipient should consider whether such information is appropriate given the recipient s particular investment needs, objectives and financial circumstances. CIBC World Markets Inc. suggests that, prior to acting on any information contained herein, you contact one of our client advisers in your jurisdiction to discuss your particular circumstances. Since the levels and bases of taxation can change, any reference in this report to the impact of taxation should not be construed as offering tax advice; as with any transaction having potential tax implications, clients should consult with their own tax advisors. Past performance is not a guarantee of future results. The information and any statistical data contained herein were obtained from sources that we believe to be reliable, but we do not represent that they are accurate or complete, and they should not be relied upon as such. All estimates and opinions expressed herein constitute judgements as of the date of this report and are subject to change without notice. Although each company issuing this report is a wholly owned subsidiary of Canadian Imperial Bank of Commerce ( CIBC ), each is solely responsible for its contractual obligations and commitments, and any securities products offered or recommended to or purchased or sold in any client accounts (i) will not be insured by the Federal Deposit Insurance Corporation ( FDIC ), the Canada Deposit Insurance Corporation or other similar deposit insurance, (ii) will not be deposits or other obligations of CIBC, (iii) will not be endorsed or guaranteed by CIBC, and (iv) will be subject to investment risks, including possible loss of the principal invested. The CIBC trademark is used under license. 27 CIBC World Markets Inc. All rights reserved. Unauthorized use, distribution, duplication or disclosure without the prior written permission of CIBC World Markets Inc. is prohibited by law and may result in prosecution.