BMO Real Estate Forum: Atlantic Outlook
- Keywords:
- bmo real estate events
This past year has been one for the books, and to say the commercial real estate industry has done better than expected since last summer would be an understatement. The industrial and multifamily sectors, and most notably housing and rental apartment markets, were reasonably immune to the virus, but retail and office proved more vulnerable. So, what’s next? The recent BMO Real Estate Forum featured a series of presentations and discussions about the outlook for the Atlantic region.
Robert Kavcic, Director and Senior Economist at BMO, provided an economic update. Tad Mangwengwende, Senior Analyst at Canada Mortgage and Housing Corporation, discussed rental and housing market trends in the Atlantic region.
John Keating, BMO’s Regional Vice President, Real Estate Finance, moderated a roundtable discussion covering key topics, including industry challenges.
Watch the video above for the full event.
Read more
[00:00:08] Host: Thank you for joining us for today's live webcast and discussion. We invite you to be a part of the conversation. You'll see a chatbox located near the video window. Click "Chat as a guest" and enter your name. Feel free to enter your questions and our moderators will forward them to the panel. We'll repeat these instructions later in the show as a reminder. It is now time to begin and I will invite your host to take the stage.
[00:00:35] Mike Beg: Greetings, everyone. I'm Mike Beg, head of BMO's Commercial Real Estate Finance Business in Canada. Thank you all for joining us today. I think we can all agree this past year has been a time like we've never seen before. Bank-centered COVID, bracing for deeper impacts in the commercial real estate books, deferring mortgage payments to ease cashflow pressures, monitoring the property rent collections and housing market trends while continuing to support large development and financing demand by the industry.
I'll not try to steal our speakers' thunder, but to say that the commercial real estate segment has done better than expected since last summer would be an understatement. The payment deferral program served their purpose and largely wound down last fall. We have not had any losses or defaults in our commercial real estate book at BMO that can be attributed to COVID.
Availability of capital across the segment is strong. We have a veritable Z or nearly Z-shaped recovery because employment impacts were largely service sector, representing about 4% of GDP.
To be certain, there is pain and ongoing adjustment in retail and office, but this is not your parents' or even our own prior commercial real estate recession experience, but a unique pandemic one where low rates and strong demand, continuing undersupply trends are driving borrowing and housing market activity. We expect that to continue through 2021 and 2022 and beyond.
We have a lot to cover over the next hour, so I'll walk through the agenda quickly, and then we'll get started. We'll start with Robert Kavcic who will kick us off with an economic update. Robert has been with BMO since 2006 and plays a key role in analyzing Canadian regional economic, fiscal, and real estate trends.
Following Robert, we'll be joined by Tad Mangwengwende, Senior Analyst at Canada Mortgage and Housing Corporation. He is responsible for providing housing market analysis to support informed decision-making and advance CMHC's objectives of ensuring housing market stability and affordability for everyone in Canada.
We will then have a round table covering key topics and answer questions that were submitted. Moderating that discussion is BMO's John Keating, my team leader in Atlantic Region, Canada. He brings over a decade of experience in real estate finance, overseeing BMO's strategy and approach to financing of real estate, as well as the relationship teams managing our complex developer relationships.
One last thing before we get started, if you're watching the event on a desktop or a laptop, you will see a chat box below the video screen. Please feel free to use it at any time during the presentation to submit questions to the panelists. Thank you for all the questions we received during the registration as well. We will address as many as possible during the round table discussion. With that, I'll turn it over to you, Robert.
[00:03:44] Robert Kavcic: Great. Thanks a lot, Mike. I'll start off with a high-level overview of what we're seeing in the economy and where we think we're going from here and then touch on some of the supply and demand fundamentals that are driving real estate right now. As you mentioned in the intro, this is nothing like any recession we've seen before.
Very quickly, last year, we came to realize that housing is, in fact, not going to struggle through this downturn, but it's going to benefit and it's actually benefited and it's run stronger than anyone, even us, thought a year ago as we were seeing this unfold. I'm going to cover some of the reasons why, and then I'll turn it over to Tad for a more in-depth look at the region itself.
First of all, when we look at our economic forecast to set the backdrop, really, it is driven by what's happening with the pandemic. Obviously, in Canada and specifically in Atlanta, Canada, now we've seen uptake in COVID cases. For the most part, I suspect, we're getting close to the peak of the third wave here just given what's happening with the vaccine rollout.
Our working assumption here is that by around the middle of the year we're going to be able to see most regions of the country opened up on a more sustained basis. Now, obviously, Atlantic Canada got through this quite a bit better than most of the rest of the country, but that's not to say there hasn't been an economic impact, and I'll circle back to that in a couple of minutes.
When you look at the overall forecast from here, for North America, it's a pretty strong one. Once we get through this current wave of restriction measures, it's pretty clear sailing for the economy as you can see in the chart here. In fact, we're probably looking at about 6% growth in Canada this year, 4.5% next year. Those are historically extremely strong numbers.
When you look at what we're assuming for Q3, and Q4 of this year, after we presumably get to something that looks more like a sustained opening, as we reach something, again, that looks more like herd immunity, we're looking at sequential growth rates anywhere from 6%, 7%, 8% going into 2022.
This is a very strong run rate. I think there's a tremendous amount of pent-up demand out there for travel, for service, for face-to-face activity that is going to extend this recovery, and it's going to make it run quite a bit stronger than most think.
If you look at what's happened with consensus expectations over the last six or eight months, be it in the economics community or at the Bank of Canada or at the federal government level, the trend has been consistently revising up growth estimates.
Not only has the economy been able to adjust and adapt to the second and third wave of COVID restrictions and able to operate in this environment but I think it's becoming pretty clear that there's a lot of pent-up demand out there that's going to keep the recovery running strong through 2022. Fiscal and monetary policy will continue to support that.
When you look at our interest rate outlook, the main story here is that you don't see any rate hikes from the Fed or the Bank of Canada through 2022. We're looking for the Bank of Canada to start moving interest rates up in January 2023.
I would say the risk is that the moves get pulled a little bit forward. In fact, just a week ago, the Bank of Canada came out and said, "Previously, we were looking at mid-2023 or later to start raising rates, now, just given how quick the economy is progressing, maybe it's the second half of 2022 story."
I would suspect that as this plays out, assuming there is nothing drastic out there that given what's happening with growth and given that inflation and asset prices are running pretty strong right now, we continue to see those expectations get moved forward if anything. Still, the takeaway here is that we're still quite a bit away from interest rate hikes at the short end.
If you look at the longer end of the yield curve, on the right side of the screen, 10-year interest rates have obviously bounced back very quickly and very strongly but we've started to see them settle into this range now, that looks about consistent with the level we saw over the course of the last cycle.
For mortgage rates, for example, at the short end of the variable end, I would say second half of '22, early 2023 is where we start to see some movement. At the longer end, and say 5-year fixed, we've already seen rates there back up about 30 or 40 basis points.
I suspect that you probably have a little bit more upside and you can see another 20 or 30 basis points over the next year or two in our forecasts there. Still, at the end of the day, it still is a low for long interest rate environment as we come out of this.
When you look across the country, I think the key takeaway here is-- There are two of them. One overall takeaway is that everybody was in this pandemic together. One of the features that we typically see in Canada when we look at regional growth is that you have big disparities across different regions. Sometimes you have Alberta running at 5% or 6%, while Atlantic Canada is really stagnant, or pre-COVID, you saw Ontario and Quebec really leading economic growth, while Alberta was lagging.
You tend to have these big divergences in economic growth. What the pandemic did was, yes, there were degrees of impact based on how challenging the healthcare outcomes were but you can see in 2020, everybody had a pretty deep recession. The flip side is that this year, everybody's seeing a pretty strong recovery.
If there's a takeaway for Atlantic Canada here, I think it's that because of the smaller and more sheltered less urban nature of the region, the economy was able to come through with a less severe downturn last year. The flip side of that is we're seeing less strength in the recovery this year.
When you smooth out the last two years and you say, "Okay, where is economic activity today?" Atlantic Canada has actually come through this pretty cleanly versus the rest of the country. With respect to the housing market, I would say this has really been one of the areas of just phenomenal strength and has been fascinating to watch what's happened in real estate through the pandemic. There's a lot of debate whether this is a supply issue or a demand issue. I think we've spent probably, seems like 5 or 10 years discussing the constraints on the supply side of the housing market, be it development restrictions, or things like that, building costs, availability of labor.
Those things are still with us. What we're seeing today is just a very acute increase in demand because of the pandemic. There are a few factors that are going on here. You can see pretty clearly on the sales chart, we haven't seen sales levels like this at all, going back through history.
Through the second half of 2020, we saw, obviously, a big recovery after the first half of the year was more or less shut down, but rather than seeing pent-up demand fizzle and fade back towards longer-term trends, we're seeing the demand actually accelerate.
There are a few factors going on here. One is that when you look at the employment situation, the labor market was actually very quick to recover across the vast majority of the country. If you look at Atlantic Canada specifically, take a look at Nova Scotia on the right side. Those are employment changes versus last February. Effectively, the province has already recovered all of the job losses seen through the pandemic.
Again, it helps because it's a smaller more sheltered economy that's been able to more or less crowd out a lot of the negative healthcare outcomes and therefore avoid some of the stricter restrictions that we've seen in areas like Quebec, which is still down 2.5% or Ontario, which is down 1.5%.
Look at the pace of employment recovery is going to strengthen from here. That's one area that has supported their rebound in demand. You add onto that just dramatic fiscal support. What we see here is that aside from the labor outcome itself, the reality is that even though employment is still down, household income is actually up significantly from pre-COVID levels.
Mike said this is a very unique recession. We have never seen a recession in the post-war era where household disposable income has actually risen. That's simply because federal transfers down to the household level have never run at this pace. Ottawa has rolled out about $270 to $300 billion worth of direct support and stimulus measures. A lot of that has flowed to the household level, and that has boosted incomes and supported housing demand and the ability to pay mortgages and pay rents and take on more debt.
The other aspect of the labor market here is that if you look at where the job losses have been concentrated, they've been down the lower end of the pay scale. This is just a quick chart on unemployment by industry versus pre-COVID levels. What we're looking at here is as you go left or right, you're moving up the employment growth chart, so down on the left side of this chart are the industries that have been hit hardest. Accommodation and food, for example, is still down 25% from pre-COVID levels.
As you go up the chart, you move up the wage scale. It just so happens that those industries that have been hardest hit are also the lowest-paying industries in Canada. The takeaway here for the demand side of the housing market, at least, from a resale perspective, is that look at the top five or six highest paying industries in this country, they are all already seeing employment well above pre-COVID levels.
Consider that, that the rebound in employment has been exceptionally strong in industries that are higher paying and therefore have a higher proportion of home buyers. We've added fiscal support to that through the income channel. We've added record low mortgage rates to that, and you have this perfect storm of housing demand.
Then what gets layered on to that is this big shift in preferences that we've seen. Out of urban centers and towards the areas with more space, and remote work has allowed that. Anecdotally, we see it out there that people are moving out of Toronto, moving out of Montreal towards Atlantic Canada to find more space and work remotely.
Some of it is anecdotal, but some of it is legitimate. I think part of it is just a complete repricing of single-detached and rural properties versus urban centers. A lot of which is going to stick post-COVID.
The demographic side is another story here that's worth touching on the demand side. Pre-COVID, we had exceptionally strong population flows in this country, and a lot of people were, at least outside of Canada, were scratching their heads and saying, "Why is housing demand so strong?" We haven't seen population growth this strong in probably 35 years in Canada. It's been a big support.
With respect to Atlantic Canada specifically, as it stands right now, international immigration flows, obviously, have been put on pause. Those flows are on hold and that typically impacts the rental market a little bit more acutely, because a lot of those flows, at least the ones that we've seen come down have been in the non-permanent residence space, and that's the demographic that takes up a lot of the rental stock.
We think, though, that as this pandemic winds down, and Ottawa has made this pretty clear, we're going to go back to immigration targets that look like 400,000 per year or more. This demographic story, at least the weak side of the story, I think, is very temporary and by 2022 or 2023, we're going to see a pretty strong snapback, and those flows are going to start to look a lot more like they did pre-COVID, which for Atlantic Canada were historically strong.
Provincial migration is another story here that has benefited Atlantic Canada at the margin. If you go back over the last 10 or 15 years, typically, the story was Atlantic Canada losing population to stronger economies like Alberta. Well, post-oil shock, that relative strength has really shifted on its head. We've actually seen migration flows back into Atlantic Canada. Part of it is just the, building out of the tech sector, this ability to work more remotely is having an impact now.
Longer-term, I think, we are in an environment where migration flows province to province for the region are going to be at least neutral if not slightly positive and that's a good thing.
Then the last thing that goes under-reported here is the millennial group. This might be more of a factor for bigger markets like Vancouver, Toronto, Montreal, even Ottawa, but even within Atlantic Canada, while proportionately smaller, there is still a millennial group. What's happening with the millennials is as they age, they're creating households. Those households [unintelligible 00:16:56] myself, once you have that second or third kid, you're looking for space.
As much as they told us over the last decade that families want to raise kids in condos in urban centers, it's just not true. When you have that second or third kid running around you want space and you can find space in two ways, you can go to a single-detached house in one of the major markets, if it's affordable for you, if not, you've got to move out.
We've seen extreme strength in some of these smaller markets simply because this shift towards remote work has expanded the effective commuting line. It's driven strengthen in a lot of these markets that just provide that more space.
What you see here, the story that I'm telling is that a lot of what we've seen through the pandemic is very much rooted in long-standing economic and demographic fundamentals. Just so happens that the pandemic really magnified those trends and it pulled forward, I think, a couple of years worth of activity that was going to happen anyway, and compressed it into a very small window. Hence why you see just this complete magnification of sales and prices.
The back end of this, if we are borrowing some activity from the future, the back end would logically suggest that we pay back for it after the pandemic and we see more stagnant flatter activity. In a lot of cases, if you look past some of the froth that's been in the market most recently over the last three to six months, a lot of this is a repricing that I think makes sense and probably will stick with us going forward.
Where we stand now here on the resale market, and I won't spend too much time on this, because Tad's going to probably pick up on the local activity, but take a look at the market balance here in Atlantic Canada and this is aggregating the group overall of sales to new listings ratio in blue. That's just a very quick proxy for market balance. The short story here is the market in Atlantic Canada has never been this tight in the resale market and prices have been following that tight market higher.
It's two factors. Listings and supply, they're not rushing to the market, but they're not exceptionally low. Really, it's the demand side that's been lifting this. Really looks like, until the Bank of Canada comes out and more forcefully says, "We're going to start to raise rates", or actually starts to do so, the psychology here is that prices are going to continue to run. It looks like that is what's driving the market now.
I suspect that the rest of this year and into 2022 before the Bank of Canada more seriously starts talking about rate hikes, it's going to continue to look pretty strong. You can see the internal conditions here in the market suggest as much.
On the new side-- Very quickly here on the new side. We don't see a lot of overhang in inventory. Post-COVID, a lot of that got absorbed. You can typically, pre-COVID, you can argue that there was a bit of an excess out there in terms of building and in terms of supply overhang in the market but the increase in demand really absorbed that.
Over time, we've seen quite a bit of stability in terms of unabsorbed new inventory. That's a positive that's helped tighten up the market. Then the other thing that's going on here is on the cost side. The question we're getting, honestly, probably the most right now in the economics team is what's going on with inflation. A short story there is that inflation is running hot, and it's probably running hotter, and it's going to run longer than most people think.
Now, are we going to go back to the 1980s where we had double-digit inflation for a sustained period and it took us to double-digit interest rates? No, but if we do have a world where we run at something that looks more in the area of 3% inflation or maybe 4% inflation, overall, that, it doesn't sound like a lot on the surface, but it's a doubling in the inflation rate from what we were used to, pre-COVID.
I think that policymakers today, the Bank of Canada, Fed, are really writing everything off as transitory, but I think just post-COVID, just given what's happened on the supply side, we are more constrained there, the demand curve has shifted out, we could see this stick a little bit longer. It could force the central banks to move off of their stance a little bit easier, or a little bit earlier, rather.
With respect to building, though, we're looking at record lumber prices, copper prices, steel prices, have all surged. On the labor side, we're starting to hear more anecdotes that labor has been a little bit harder to pull back into the market, just given very generous benefit programs out there that still haven't wound down yet.
These areas are all pushing prices up, or costs up. In some cases, in the US, we've seen studies where the cost of building a new advertised unit is about 10%, 15% higher than it was a year and a year and a half ago. That's filtering in through the supply side as well. That's probably an issue that's going to stick with us for a little bit longer as we go forward.
Finally, just on the rental market, I touched on the demographics here a little bit. I think if we are seeing extreme strength in the resale market, the flip side is that the rental market has been a little bit soggier. I don't want to say it's depressed or it's down because it's actually held up relatively well, but it's soggier, for sure, as are some other areas of the commercial market that Mike touched on off the top.
Part of it is the fact that just job losses have been concentrated among the renting population. Flip side is that the federal government has really supported that through transfer payments. We haven't seen a big increase in defaults and things like that. Really, it's an immigration story on the rental side.
As I said at the start, I think we can pretty safely assume that as we come out of this pandemic, those immigration flows are going to pick back up. If there is any rental stock out there that's overhanging on the market, I think we're at the point now if you can just hold on through this pandemic and start to see those flows come back, I'd be pretty comfortable in those areas of the market getting absorbed again, post-COVID.
In some of the bigger markets like the Torontos, the Vancouvers, the condo sector has been a bit of an issue in that the economics there have changed. Pre-COVID, we were looking at cash flow negative purchases for pretty much anyone with 20% down in those markets. They were low lying on price growth or rent growth. The rent growth didn't turn out to be the case. Price growth went stagnant, so the economics changed.
In a lot of cases, investors were relying on the short-term rental market to make cash flow make more sense. Of course, the short-term rental market dried up with all the travel flows gone. That area of the market has been a little bit softer as well. Again, I would view that as temporary. I think, post-COVID, I think the major urban centers are going to come back quicker and more strongly than most people suspect at this time.
That's where I will probably leave it off. Just to summarize here. For Atlantic Canada, overall, I think the strength that you're seeing in the market in Atlantic Canada is consistent with what we're seeing across the rest of the country, and, frankly, across a lot of the developed world as well.
Atlantic Canada is not alone here. A lot of it is rooted in underlying demographic and economic fundamentals that just so happened to get pulled forward and magnified by the pandemic. Are we going to see a payback for some of the excess of froth we're seeing today? I would say probably. Anytime you see prices run 30% or 40%, you tend to get caught up in a world where the last leg of price growth is simply because of expectations of price growth.
If you look back to what happened in the detached market in areas like Toronto or Vancouver in 2017, we actually did have a 10% to 15% correction that lasted about three and a half years in those markets. It wasn't because the fundamentals changed, the fundamentals were still there. It was just working off some of the excess froth that built up through 2016 or early 2017.
I think that's roughly where we are today. There's going to be a little bit of a payback, a little bit of undoing of some of the froth, but at the end of the day, there are still economic and demographic fundamentals here that support the housing market and support the rental market going forward. I will leave it at that. Mike.
[00:25:22] Mike Beg: Thank you, Robert, for your insights and update. I'd now like to hand it over to Tad Mangwengwende, who will be giving an update on market trends and what's happening in the Atlantic region. Over to you, Tad.
[00:25:37] Tad Mangwengwende: Thanks, Mike. Good morning, and thank you very much for the opportunity to share some of our information here at CMHC. The outline of the presentation just briefly. I'll talk about the high level trends so that we don't get bogged down in the minutiae of the detail, but as we go through this presentation, I'll just alert you to some of our reports that will give you a more detailed breakdown.
If you want to revisit some of these topics, you are more than welcome to do so. The information will be available on the CMHC website. First, we look at the new home construction trends, then we'll look at the resale market, then the housing market fundamentals before we finally look at our Housing Market Assessment, which ties all these together in some metrics that put together what's happening with the sales and listings relative to what's happening with the overvaluation or non-overvaluation, and what's happening with the acceleration of prices or the non-acceleration of prices.
Without further ado, let's look at the story for Halifax. As you can see over the last decade, and I'd like to really emphasize the importance of trends, particularly in a year like 2020, where we had an unprecedented impact or unprecedented developments in the market, to look at whether or not something was completely out of keeping with what we've seen before, or if it was a reinforcement of an existing trend.
As you can see in the housing starts story, the trend has been one way. At the beginning of the decade, we had a decline and then we've started to see an increase with an increasing proportion of the apartments in terms of the composition of the housing market starts.
If we look at the case for Moncton, we see very similar trends, decline at the beginning of the decade with an increase and a particularly pronounced 2020. Again, with that increased component of the apartments.
We move to the third CMA in Atlantic Canada. We see, again, a similar trend, decline at the beginning of the decade, and then an increase in the second half of the decade.
Now, it's important for me to point out the reason why I'm emphasizing that the trends are similar. These are three distinct markets, where there is no reason why the markets should be moving in tandem unless there are some root causes that underlie the movements or the patterns that we are seeing.
In the case of the three CMAs that I've just shown you, if we were to overlay the population growth numbers, you will find that after the last census we've seen the numbers begin to steadily grow in Atlantic Canada, primarily because we're able to draw and retain more migrants than we were doing prior to 2016. This is something that I will show you in an interprovincial chart when we look at the housing market fundamentals.
Just to underscore that point, here is the chart for St. John's, where, again, this market is working with its own idiosyncrasies. We had an increase at the beginning of the decade, and now we've had a gradual decline over the last six, seven years.
If we turn our attention to the resale markets. In 2020 at this stage, this has become-- This is now passe. I'm sure many of you will already know that we had some significant increase in terms of the sales that we were seeing in 2020. As you can see with this heat map, that we are pretty much in double-digit territory, or we were in double-digit territory right across the board, even in Prince Edward Island, 9.6%, practically 10% increase in the sales.
If we look at the beginning of this year, we see that that sales growth has continued into 2021. Something that I'd like to just point out here is you'll notice, instead of looking at the quarter-over-quarter numbers, here, we're looking specifically at January to February versus January to February. The reason for this is that as the Q2, 2021 plays out, you'll find that many metrics that use year over year figures are becoming a little bit more inflated than they ordinarily would be. This is a quirk of the mathematics rather than an actual inflation of the numbers.
Yes, the sales are higher, but if we compare a rather muted Q2 last year when we were at the beginning of the pandemic and relatively normal activity in March in 2021, we get an even more pronounced effect. This is to say that we are still seeing the sales growth even here in 2021.
Moving to the listings, we're now looking at listings that are in keeping with a trend we saw last year where the listings still lag the growth in the sales, which is showing us that while the demand for housing is increasing, we are not seeing a commensurate increase in the availability of homes.
In fact, if we look at the most recent metric provided by CREA, the Real Estate Association, it shows that the months of inventory right across the Atlantic Canada have declined to around two months of inventory in New Brunswick, in Nova Scotia, and Prince Edward Island, as opposed to the 10-year average, which was near 11, 12 months of inventory.
What we are having is a market where there's increasing demand for homes, but there's an increasingly, or rather, there's a shrinking availability of the homes for those people to buy.
This leads us to the story that many people will be seeing, a story that's reported quite widely, which is that prices have increased quite dramatically. If we look at the trends in the prices, just so that we can see whether or not a price increase is, again, in keeping with what we were seeing before, so to Robert's point, is this a magnification of something that was already happening or is this a reversal of the trend?
We see that, in three of the four provinces, we were already seeing increases in prices and then had a more pronounced increase in 2020 because of some concentrated impacts or some of the things that Robert was talking about. We had higher interprovincial migration because Atlantic Canada faired relatively better than the rest of Canada in terms of the impact of the pandemic.
In the case of Newfoundland and Labrador, such was the power of the impact on prices that it even reversed a trend that had been building over the last couple of years. If we look at the beginning of 2021, the prices are still continuing to grow. If we look at, specifically, the case of Halifax, we have a 34% increase over the first two months of the year relative to the first two months of last year.
The sales are up reflecting that more and more people want to be involved in the homeownership market. The availability of homes to buy is declining as shown by the trend in the listings, and so, ultimately, we are seeing this playing out in terms of the strong growth of prices.
Now let's turn our attention to housing market fundamentals because, ultimately, the story that I would like us to focus on is, what is driving this? What is underlying all these changes that we're seeing?
The first element that we should look at is what's happened with the population growth. Now, across Atlantic Canada, many of you will already know that the provinces have been acting deliberately to try and draw and retain more migrants. We have the Atlantic immigration pilot, we've got provincial nomination programs, as well as annual targets in which we are trying to ensure that we are addressing key issues that have been long-standing in our markets.
For example, the labor shortage and skills mismatches, which some of you will be aware of where we've had consolidation of health services in New Brunswick, because there aren't enough EMTs, or we don't have enough people in the trades, specifically, people who have expertise in working with cement. All these issues have prompted a need to try and draw and retain more migrants.
When we are seeing population growth, which we started to see since 2016, this is grounded in some very real issues, which are still needing to be addressed. This is a particularly important point to note because even though we are faced with the more immediate demands of the pandemic, it is not lost on- or rather it should not be lost on us that the issues that underlie this, which are not top of mind at the moment, are still there.
Atlantic Canada still has an aging population. We still have fewer people entering the workforce than those that are potentially retiring. This need for the population to grow is going to remain. If we, again, put this in the context of we already have people buying many homes, we already have an issue with the supply of homes, but the imperative to grow is remaining strong.
If we add to that higher savings rate. Robert pointed to the disproportionate impact of the pandemic on lower-income households and the fact that it allowed higher-income households to be able to save. We know that there were houses that were not able to put down payments on homes and that some people felt more comfortable about their financial position, such that they could transition from the rental market into homeownership because that was something that they'd wanted to do.
We also see that we have low interest rates. I want to avoid repeating some of the things that Robert has already mentioned, but low interest rates feed into low mortgage rates, which also induces more people to come out into the market to buy homes.
On the cost of production, we've seen an increase in the cost of production around the labor, around the lumber costs. We know this from anecdotes that have been shared by contractors and developers who have spoken specifically about inability to get enough lumber supplies or having to absorb significant increases in cost when they finally do get those lumber supplies.
It is also worth noting that when it comes to just construction costs, Statistics Canada produces a building cost index, and three of the top CMAs in terms of increases in building costs in 2020 were Moncton and St. John, and New Brunswick.
We've also seen outside buyers. Some of those people who are trying to find more space are coming to Atlantic Canada. Anecdotally, you'll hear or you'll have read of people who have been able to sell their property in Toronto and get a larger property somewhere in Atlantic Canada for a fraction of the price.
The listings growth is putting pressure on price because we are seeing a decline in that. All this is feeding into affordability because if we were to juxtaposition the increases in incomes against the increases in the prices, we can see that the rate at which the prices are increasing is significantly greater than the rate at which the incomes of individuals, particularly individuals here in Atlantic Canada would be increasing.
Then we also have the rental market vacancy rate, which is particularly low across Atlantic Canada. In Halifax, it is at 1.9%. In Moncton, it's at 2.8%. We produce a rental market report, which is available on our website, which will give you a more detailed breakdown of exactly what the rental market looks like.
What this means in the context of what we're talking about is the region is still looking to grow. The need to grow remains strong. The housing market is tight, the supply is limited, and the rental market where people traditionally would find themselves is also tight.
Ultimately, we're finding ourselves in a situation where the message is very clear in terms of the intentions of the provinces, and the need for the provinces to grow, but the availability of supply and the availability of the homes for people to enter is still limited.
I have this particular chart I want to use as an example. I don't want to commandeer this presentation and go into a deep dive into some of these, but just to underscore the power of interprovincial migration, and this thing called the future of work for Atlantic Canada, here are the migration patterns over the last five years.
We see that in the brackets of people who traditionally form first-time homebuyers, the people in their late 20s, early 30s, going into their 40s, for years, they were going out West. As Robert was pointing out, in Atlantic Canada, anecdotally, people just knew, "Well, at some point, people just leave Atlantic Canada," but we started to see people moving in the opposite direction.
We started seeing people moving in the opposite direction before the pandemic came. There have been questions on, are people only moving to the Atlantic Canada because we're in the middle of a pandemic? No. We saw more people move during the pandemic. If we look at some of these numbers, in some of these 2020 numbers, they're still elevated, but people have been moving to Atlantic Canada since before the pandemic.
If we think about the future of work and remote work, one of the biggest challenges with drawing and retaining people in Atlantic Canada has been the depth of the labor market. It is not very difficult to see that despite all the advantages of potentially living in a Charlottetown or in a Moncton or in a St. John's, in Newfoundland, that the depth of the labor market in Toronto or in a Vancouver or in a Morell, will still mean that they still are able to draw and retain more migrants.
If there's a decoupling of where someone works and where someone stays, if someone ostensibly is working in Toronto but living in Halifax, then we may see even more people opting to come for the bigger spaces, being able to be closer to the downtown core, the amenities that are available to those of us who are living here in Atlantic Canada.
Let me very quickly move on to our Housing Market Assessment. Now, our Housing Market Assessment is a publication we produce every quarter, which speaks to some of the things that I'm talking about, but in greater detail, and specifically in reference, or specifically with reference to thresholds for the individual markets. Here, I'm using an old Q4 Housing Market Assessment deliberately, so that this doesn't become the focus of what we're going to be discussing, but I would invite you to go and look up the latest report which is available on our website. In this, you will see that where we say the sales are growing relative to the listings, you will see that we have a metric called overheating, which keeps an assessment of whether or not there's a balance between the sales and the listing.
We also look at the price growth, not just that prices are growing, but is there an acceleration in those prices? Is the rate of growth itself growing? We also look at whether or not the market is overvalued. We know that housing market fundamentals have improved or increased in the sense that we have more people, so the population growth. We know that there were lower interest rates.
We know that people had higher incomes in terms of some of those transfers, but we still find that there's a disconnect between the prices we see in the market and the ones that can be explained by housing market fundamentals.
On that note, I think I will conclude my presentation with an invitation to please visit our website to see more information and get a more detailed breakdown and visualizations on some of these markets. You can then organize these by different geographies. Thank you over to you, John.
[00:41:22] John Keating: Thank you, Dan. We'll now move into a round table to answer some of your questions. As a reminder, if you've not had a chance to submit a question yet and would like to, please submit using the chat Q&A box found below the video screen. Let's get started.
With regards to some of the challenges we'll face going forward in Atlantic Canada with regards to historic population growth we've seen and this is likely to continue, what do we see as being some of the greatest challenges that we'll face and how can we potentially overcome those as we go forward? I'll pose this one to Mike first, and then we'll go to Tad and Robert for follow-up. Thank you.
[00:42:19] Mike Beg: Thanks, John. My opening comment just in terms of challenges would be on the supply side. This is not to discount any of the comments about some of the hyperbolic almost year-over-year appreciation rates in new home prices north of 35%. The demand side is important, but I think the issue that I see, not just in this market, but right across the country, is that we do have less initiatives policy-wise focused on the supply side.
What that means is that if you have an easing monetary policy that's supporting demand, if you have a strong immigration policy that in Canada is not a political one, all three parties are pro-immigration. I think this is a Canadian thing. All of these things, by design, create demand, but on the supply side, we don't have a, by-design, federal housing policy that would drive provincial and city policy.
I think it's important that we look at ways to increase density, availability quicker, and approval processes that are quicker. I certainly have conversations with clients from Halifax to Vancouver and points in between about how fast that supply can come to market. We have some markets where it takes five years to get a project to prove when it used to take three. That would be my opening comment or response to that question, John.
[00:43:49] John Keating: Thanks, Mike. Robert, your thoughts on this subject?
[00:43:56] Robert Kavcic: Longer-term, Mike covered the supply side well. I certainly totally agree with all of that. Anything to improve the elasticity of supplies will be more than welcome in every market. Some, obviously, would be tougher than others, but on the demand side, I think longer-term-- We covered the pandemic, I think, pretty well between the two of us, what's going on here longer-term once this is over and once we get back to somewhere where it's more normal.
I think the same challenge for Atlantic Canada is one that was existing in the years pre-COVID. That is, yes, it's easy to pull in migrants internationally with big federal targets, which tend to get dispersed pretty evenly across the country but the challenge after that is retaining those international immigrants into that local labor market.
Typically, what you'll see is, yes, you'll come into a Nova Scotia or a New Brunswick and, over time, will gravitate towards the stronger job markets and it'd be a Toronto, Montreal, Ottawa, Vancouver or if the energy sector is strong out into Alberta. The challenge after this is done I think is the same one that policymakers in Atlantic Canada have been dealing with for years and that's just retention of the population that does come in. That's through a strong labor market and if we're right and some of this ability to be a little bit more detached from your physical place of work sticks with us, maybe that's become easier over time.
Even like in the education space, I know that the provinces are flooded with incentives to retain graduates in the local labor market, and that's-- After the pandemic is done, I think that's a big issue on the demand side that we'll have to get back to at some point.
[00:45:43] John Keating: Thank you. Tad, any comments on your side?
[00:45:47] Tad: Yes, two. It's worth pointing out that Statistics Canada came out with a report in 2018, which reflected an increase in the retention rates. Five-year retention rates across Atlantic Canada, they're still the lowest in the country but it is pointing to a trend where more and more immigrants are choosing to stay in Atlantic Canada, and if they are staying for five years, then they're more likely to be getting into the spaces where they will be buying homes.
Then to the broader question of how do we address supply issues? It's important to remember that from across Canada perspective, there are many people who are needing to get into affordable housing, well, at the low-income levels, they're the people who can afford to buy homes.
It's very hard to come up with any generic solutions and I would always encourage people to take some of the information that we share here, and then put it to the people who are entrusted with policy decisions, because that's who you will hold accountable.
What is very clear from the data is there's more supply required because the reason why we need the people here has not gone away. The issues on the tax base, the issues of an aging population, that is pretty much grounded in what Atlantic Canada is dealing with. The supply issues are ones where every opportunity to try and find inducements for every different type of potential supplier is important to the region.
[00:47:14] John Keating: Thanks, Tad. My next question was submitted to us prior to the event, and I'll throw this one over to Robert. It's with regard to, we've seen a lot of concerns at all levels of governments with regards to some of the rises we've seen across housing markets and major municipal centers. Is there any expectation that we'll see any controls implemented over the next several months on financiers or by financiers in order to attempt to cool the housing market in Atlantic Canada but also across the country more generally?
[00:47:54] Robert: It doesn't seem that way. There's been a big conversation about this. Whether or not measures should be taken to cool demand. Personally, we're a little concerned, not so much in Atlantic Canada, but some of the other markets that over the last couple of months that the strength of the housing market has started to feed on itself, which becomes concerning because, eventually, you have to pay that back. We saw that in 2016, 2017 in Toronto and Vancouver.
There was a lot of discussion about some measures out there to cool demand. There was talk about things in the budget, like taxing principal residences or increasing the inclusion rate. Those are policies that, frankly, were not ideal, they were not good and then we didn't see them.
There were other areas that were discussed. Like a short-term speculation tax, obviously, we didn't see that. Things like addressing the way we buy homes in this country through blind bidding and things like that. Fortunately, those measures take a little bit longer to push down through local real estate boards.
Really, at the end of the day, so it doesn't sound like we're going to see any hard policy measure from Ottawa, or from CMHC. CMHC did tighten up their qualification rule, but at the end of the day, it was a very incremental increase in the qualifying rate above and beyond a rate that's already quite strict, to begin with. It added about 30 basis points of qualification tightening there. I don't think that's going to have a huge impact. I don't think it changes the psychology in the market, which is most important.
At the end of the day, I think it falls on the Bank of Canada. The Bank of Canada has admitted openly a few times now that they're seeing excessive strength in a lot of markets in Canada. One of the reasons they probably pulled forward their guidance on when they're going to actually be able to raise rates is to just divert the conversation away from this idea that rates are never going up because that is what stocks a lot of the excessive strength.
To answer your question, no, I don't think we're going to see a big policy measure announced beyond what we've already seen from CMHC. I think it's going to come down to the Bank of Canada to tighten up the guidance and eventually raise rates before we see demand cool off.
[00:50:08] John: Thanks, Robert. Tad, this question comes from the audience. Are you seeing from or hearing from local governments in the region about any easing of development requirements in order to try to meet the demand that we're seeing across Atlantic Canada and head off inflationary pressures in the housing market?
[00:50:31] Tad: Sorry, there was a break, could you repeat that question? You said we heard reports off?
[00:50:37] John: Have you heard anything about local governments easing development requirements to meet demand and head off inflation in the housing markets?
[00:50:49] Tad: Not anything specifically about heading off demand or addressing that. We do have regular contact with local governments because they are key stakeholders in terms of ensuring that there's a provision of adequate housing.
We do know they have made concerted efforts to try and improve the ability to get developers to be able to get projects approved, say the permitting process. From our end, we see that in an increase in the number of building permits and we've seen a correlation with the increase in the number of starts in terms of the supply of the housing market, but beyond that, we wait to see any policy measures reflected in the data before we are in a position to say, this is actually what's happening or this is working or this is doing that.
[00:51:41] John: Thanks, Tad. I'll direct the next question at Mike. With regards to new construction, we have seen a large increase in cost of materials over the last year and continuing to see so in the current season's construction market. Do you see or have you seen any relief on this impact looking forward as we come out of the pandemic?
[00:52:14] Mike: Thanks, John. I'm going to defer to Robert in a minute because I think he might have a better longer-term perspective on some of the components of the costs that go in. What I would say that we're seeing across the board is that the price levels and the overall revenue levels on the projects are keeping up and surpassing the growth in the cost.
We haven't seen an erosion of project economics. Quite the opposite, the project economics are pretty stable and firm for all types of residential construction, whether we're talking about rental or for sale residential construction. I don't know, Robert, if you want to add a longer-term perspective to some of the input costs on construction?
[00:52:58] Robert: Sure. We touched about inflation earlier on. That we're at, potentially, a point where we're going to see a little bit of upside run rate for inflation. I think building costs fully fit into that story.
Part of it is that the shift in demand happens so quickly and I'm not just talking about Atlantic Canada now but Canada overall. The US, especially, on the demand side and the construction side has really pulled forward a lot of activity that was coming down the pipeline and is here with us to stay now. I think the US is at the start or the very early stages of a decade or more bull market in housing and construction is going to follow that.
A lot of that is driven by demographics as well, similar to in Canada. The problem is that post-financial crisis when the US housing market was very weak, there was a lot of under-building and incapacity for materials, be it lumber or other materials that go into housing.
We have a very acute demand shock that fundamentally changes the demand side overnight. It takes a lot longer for supply to come on. If you remember what sawmill suppliers were doing early in the pandemic. They figured, "Well, this is going to be very negative for demand and for construction activity," so they pulled back production, which was a totally rough thing to do in hindsight, but, at the time, who really knew?
Longer-term, fundamentally, we have a lack of ability to meet demand because of a decade or so of underinvestment in the production chain into housing. Partly because of what happened after the financial crisis.
One of the short rules of thumb as an economist is when you see a fundamental shift like this, usually, it's the right thing to assume that it's going to run longer than most people think and run stronger than most people think. That's where I would suspect we are on the cost side of things right now.
[00:54:55] John: Thanks, Robert. A follow-up question for you. When we look at the Bank of Canada and its plans to raise rates over the next couple of years, whenever they get to it. Can we likely expect these rises to be steady, a steady rise back to pre-pandemic levels? With that rise, do you see material impact or do you see it as a material risk on housing markets across the country given the amount of demand and potential immigration we'll see going forward?
[00:55:33] Robert: We would say, yes, we're going to see rates start to rise around the turn of 2022, 2023 and the pace will be pretty gradual. We're a couple of years out, so you're digging into some details that will, obviously, change as even this year plays out, but every six months or so, we're looking for a rate hike in our forecast going forward beyond the end of 2022. A pretty gradual and steady pace from the point when we see rates lift-off.
As for the endpoint, it's debatable where the neutral rate is. Some say potential growth is lower than it was pre-COVID, some say potential growth is higher. Our working assumption right now is that rates probably settle in a little bit lower in a neutral environment than pre-COVID. That's very consistent with the trends we've seen over the last 25 years or so, where every cycle effectively has seen the neutral level for the interest rate end up a little bit lower than it was in the previous cycle. There are a lot of factors at play there, the demographic side and things like that.
Yes, that's where we would be on rate hikes. As far as the risk goes, I don't think there's a systemic risk in the financial system of rates going up. Part of what we've seen over the last decade has been the CMHC in Ottawa tightening mortgage rules, with really an eye on insulating the market from higher interest rates.
As an example, you walk into a bank today, you might be paying 1.8 or 2% for five-year fixed, you're qualifying at 479. Even if rate hikes start earlier and they run a little bit faster than we currently have in our forecast, we're probably not going to 479 or 5% on five-year fixed-rate mortgage even by the end of the cycle. From that perspective, we're insulated in terms of defaults in a broader impact on the economy in the financial system.
If we go back to, say, two and a half, 3% mortgage rates, is that going to slow the pace of home price growth? Is it going to take froth out and give us a little bit of a correction? If it happens very quickly, absolutely. The market is that strong right now and that we're so tied to sub 2% mortgage rates that if we get a shift that's quicker and stronger than we think, it'll take some of the recent price growth off, I think, for sure. There's a big difference between that and what we saw in the US 10 years ago where it's a financial system and economic issue, and I don't think we're going there.
[00:58:05] John: Thanks, Robert, and thanks, Mike and Tad, for your input on this panel, and thank you, everyone, for joining us here today. We hope that you've enjoyed this today's session and I want to thank you again for taking time out of your busy day to spend time with us here.
On behalf of BMO, we want you to know that we're thinking of you, your families, and your organizations. We're here to help. We've been through uncertain times over our more than 200-year history and we have a strong capital position and we're well prepared to serve our clients.
We hope our firm commitment to the real estate market in this region and our commitment to you, our clients, has been discernible. As a reminder, today's call was recorded and is available for playback. You'll receive details on how to access that in an email later this week.
Additionally, if you submitted a question that wasn't answered, we will be in touch to provide additional information. This concludes our call today. Thank you, be safe and take care.
Mike Beg
Head, Real Estate Finance
Mike Beg as Head, Real Estate Finance, Canada is responsible for management of BMO’s Commercial Real Estate Finance group and its client relationships across …(..)
View Full Profile >This past year has been one for the books, and to say the commercial real estate industry has done better than expected since last summer would be an understatement. The industrial and multifamily sectors, and most notably housing and rental apartment markets, were reasonably immune to the virus, but retail and office proved more vulnerable. So, what’s next? The recent BMO Real Estate Forum featured a series of presentations and discussions about the outlook for the Atlantic region.
Robert Kavcic, Director and Senior Economist at BMO, provided an economic update. Tad Mangwengwende, Senior Analyst at Canada Mortgage and Housing Corporation, discussed rental and housing market trends in the Atlantic region.
John Keating, BMO’s Regional Vice President, Real Estate Finance, moderated a roundtable discussion covering key topics, including industry challenges.
Watch the video above for the full event.
This is part 2
of a
3-part series on
BMO Real Estate Forum
PART 1
BMO Real Estate Forum: National Outlook
Mike Beg | March 22, 2021 Commercial Real Estate
The past year has been a rollercoaster ride like no other, but the commercial real estate industry staged a dramatic recovery beginning last summer. …
PART 3
BMO Real Estate Forum: Quebec Outlook
Mike Beg | May 18, 2021 Commercial Real Estate
When looking at the last 18 months, the commercial real estate industry has fared far better than anyone expected. The industrial and multifamily sec…
Tell us three simple things to
customize your experience
