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Monday, September 24, 2012

Canadian and US Residential Markets: A Study in Contrast

By Amy Erixon, TORONTO

Hardly a week goes by without a dozen articles expressing divergent views on Canadian residential construction levels, prices and prospects.   Home ownership levels are now higher in Canada than in the United States (70% versus 65.4%), despite prices more than three times as high on average.   Will the shoe drop in Canada, like it did in the US?  Will the US ownership market turn around?  And if-so, when?  A current snapshot reveals there is a condo boom going on in Canada, and an equally vibrant apartment investment renaissance in the USA.   How long will these last?

Eventually, all things being equal, prices revert to the mean.   However, all things are not equal. There is a lot of intervention occurring, directly and indirectly in residential and financial markets in both countries, with profoundly different results.  It’s instructive to look at the differences in governmental policy, the role of investor confidence, and capital availability for insights.   In the end, market timing likely hinges on investor confidence; which is increasingly tied to governmental policy.   Interest rates will stay low for some time, oversupply is getting absorbed, and liquidity is ample.  Governments are getting these pieces of the equation right if the goal is improving real estate markets.   Real estate is enjoying improved image relative to other investment alternatives, but frankly other choices these days are pretty unattractive, and that’s not likely to change very quickly either.  How long will confidence hold, and whether very low interest rates cause a second asset bubble - are important questions for a later blog.  Let’s start with assessment of current conditions and the impact of public policy on respective markets. 

Issues from cursory view of Canada:

  • Prices are very high and at record multiples to median income
  • Massive amount of new condo construction
  • Increasing percentage of units being acquired by investors and foreigners
  • Numerous non-traditional players jumping in the game

Factors that are the same in the US and Canada:

  • Shortage of attractively priced investment alternatives with underwrite-able risk
  • Government agencies subsidizing credit flowing to the housing sector, with different approaches being utilized in Canada and the US
  • Record low interest rates which if raised could squeeze both owners and buyers
  • Gateway markets seeing inflows of international “fear and flight” money
  • Rising unit prices/values, and a gap between existing prices and cost of new construction

Differences in Canadian vs US Government Housing Policies relevant to the market:

  • High land values and rent control in Canada means virtually no purpose-built apartments, creating a natural demand for rental of investor-owned condominiums. 
  • No sub-prime lending or personal residence mortgage interest deductions in Canada
  • Canadian government actively trying to cool speculative activity and both supply and demand
  • US Government is actively trying to move assets off its balance sheet and into the market

With higher income security in Canada and more disposable income to allocate to housing, (due in large part to do with differentials in public funding for health care, university education, public schools and social security) ownership is preferred.  But the differential in pricing between the US and Canada is likely unsustainable given the similar economic profile of the residents of each country.  To deal with the rising prices in Canada the market has been shifting away from single family toward smaller, less costly multi-family unit mix.  These units represent an easy entry, attractive investment property option for domestic and foreign individuals, as well as attractive homes for young people entering the market and empty nesters.  Most projects are located in urban centers and amenity rich locations.  So long as supply does not grossly outpace demand, this segment of the market should hold its own.    If demand lets up, the sector could see significant oversupply.

The US market has likely overcorrected.  While showing signs of recovery, it remains in serious oversupply.  The lower confidence levels are manifesting in surging ranks of renters.  Apartment REITs in the US are outperforming other sectors.  The surge in demand has been so strong that in the past 6 months 2 Canadian REITs have been IPO’d and numerous funds and clubs whose strategy is acquisition of US apartments have been formed - including our own product which launched in May of this year. 

Net/net, future market prospects largely come down to buyer and seller confidence holding or improving.  If confidence sags, there is a chance of significant dislocation in Canada, and reversal of current recovery trends in the US.  If it holds, we will enjoy a good run.   

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