Pent-Up Supply?

Steve Saretsky -

News on the Coronavirus front has been getting better, and there appears to be some light at the end of the tunnel. As we brace for a possible re-opening in the next few weeks, there is a lot of talk within the real estate industry about the direction of the housing market. Nearly all of those discussions focus on the idea of “pent-up demand”. This belief that a swarm of eager buyers, finally released from their quarantine shackles, will be tripping over themselves to snatch up condos, thanks to a flood of cheap credit and a lack of supply.

But what if demand remains impaired?

While the virus may be fading, it is still very much with us, and it seems it will be here for the foreseeable future. All this talk about money printing and stimulus saving us all, as if we can simply paper over a wave of insolvencies. The reality is many businesses will not survive, as John Mauldin of Mauldin Economics recently noted, unlike manufacturing, retailing, or agriculture, service businesses can’t hold inventory. They can’t just close for a few weeks and then make up the lost time. There is no second chance to sell that hotel room night, plane seat, restaurant meal, haircut, Uber ride, or cocktail. Revenue has been vaporized, not deferred. It will take years to make up lost revenue, including all the jobs that have been eviscerated.

The unfortunate reality is we will be stuck with a double digit unemployment rate for quite some time. The real economic damage has yet to materialize. Has anyone asked what demand will look like under that scenario?

The demand for housing consists of employment, population growth, and the availability of credit.

We already know employment prospects are bleak. Many businesses wont survive. For those who do get re-hired, good luck asking for a pay raise. That’s a net negative for rents, or in other words, a landlords future expected cashflow.

What does population growth look like in a world of limited travel and weak job prospects? Natural population increase in Canada was near record lows pre virus. In fact, our recent population boom was via non-permanent residents. This cohort is made up of foreign students, work permit holders, and refugees. They were responsible for nearly 35% of our total population growth, a record high. This cohort has proven to be cyclical, mirroring the business cycle.

In BC, we are particularly to vulnerable to a reduction of migration flows. Net immigration was 14x as large as the net natural increase in the population (i.e. births less deaths), versus 4.9 for Canada as a whole, per Capital Economics.

Meanwhile the access to credit has slowly tightened over the past few weeks. Banks are becoming more conservative, and for good reason. Refinances and home equity lines of credit have been reigned in. But what did you expect? Their customers are under strain, coming into this crisis with record amounts of debt and a near sixty year low in savings rates. Banks are trying to protect their collateral (your house), and have dished out over 720,000 mortgage deferrals- that equates to 15% of all residential mortgages on their books as per data from the Canadian Bankers Association.

This doesn’t include mortgages at local credit unions or in the private/ shadow banking system. In other words, deferral or no deferral, foreclosures will rise, and probably meaningfully.

Now that we have a somewhat better understanding of demand, lets take a look at the other side of the equation. I have so far heard very few people talking about pent-up supply. Who could fathom such a thing?

What we know is that the Canadian housing market has enjoyed a prosperous few decades. This bull market has been generous, and over the years, has brought on speculation of ever rising prices. Thus it has encouraged many Canadians to invest in additional property. Will some of these investors flinch and try to liquidate if they believe prices may move lower? Do they have the ability to withstand missed rent payments from unemployed tenants? What about AirBnB landlords? Today, we don’t have that answer, but we will soon find out if this results in additional supply.

What we know for sure, is that a wave of new home construction is nearing completion. In Vancouver there is a record 44,000 units under construction today, and in Toronto that number is 73,000. Furthermore, housing starts remain elevated. In other words, the supply is coming regardless of whether the demand is there to meet it. New supply can not simply be shut off.

At the end of the day, I’ll be the first to admit I have no idea how this will all play out. The Canadian housing market has proven time and again to be incredibly resilient. I can merely assess probabilities, and I think the probabilities suggest supply will outpace demand over the coming 12 months. Is anyone prepared for that? I am confident we must continue to ask the hard questions, even if they may be uncomfortable.

Three Things I’m Watching:

1. April sales for Greater Vancouver dropped 39% year-over-year. This was the slowest April on record.

2. The number of homes under construction in Vancouver & Toronto combined sits at all time highs.

3. Per Desrosiers, Canadian new car sales fell 75% year-over-year in April.

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The Saretsky Report. December 2022