The curious case of Calgary’s residential real estate market
Is it really different in Calgary when it comes to residential real estate?
by Max Fawcett
Photograph Bryce Meyer
“It’s different here.”
It’s a common refrain among people who build and sell real estate, a soothing lullaby aimed at calming fears about global economic trends and macroeconomic worries. And as millions of American homeowners discovered in 2008, it’s also usually a load of horse manure. Given that, it’s fair to wonder whether those saying the same thing right now about Calgary’s real estate market can – or should – be trusted.
After all, banks, economists, even rating agencies are warning that homes are overpriced in this country. The only thing they seem to disagree on is how overvalued they are, and how far they might fall. Moody’s, for example, pegs it at 44 per cent. In late August, The Economist published a story suggesting it was even higher than that, arguing that Canadian homes are overvalued by 74 per cent on a price-to-rent basis and 30 per cent on price-to-income. Even the OECD chimed in, suggesting that Canada has the third-most overvalued housing market in the developed world. And don’t even get perma-housing bear and former Member of Parliament Garth Turner started on the subject.
But here’s the funny thing: in Calgary, and to a lesser degree in the rest of the province as well, it looks like it really is different. It’s reasonable to assume that Toronto homeowners could be in for a rough ride, given that the median price of a detached house there now costs 7.2 times the median household income (anything over 5.1 is defined as “severely unaffordable” by Demographia, which tracks affordability internationally). And Vancouver’s housing market has become completely divorced from reality, with the median price of a single-family home coming in at 12.4 times the city’s median household income. But in Calgary, where the median household income is higher than it is in both Vancouver or Toronto and average home prices far lower, affordability doesn’t appear to be a problem. The ratio of median house price to median household income is a comparatively modest 4.0 – at the upper edge of what Demographia defines as “moderately unaffordable.”
Warren Phipps, a real estate broker with Mountain Park Real Estate, thinks the talk of a housing bubble in Canada overlooks the reality on the ground in Calgary. “Everybody compares everything with the rest of the country, but I don’t think Calgary moves the same way,” he says. “Since 2008, Canadian real estate prices have gone up 20 per cent. But what people forget is that Calgary peaked in 2007, and we were on a slow, gradual price decline until 2011. If you bought a house in 2008, you’re not selling it for what you bought it for today.” Ann-Marie Lurie, the chief economist with the Calgary Real Estate Board (CREB), agrees. “It’s not that prices can’t decrease, because they did,” she says. “When you think about what happened in the condo market, prices haven’t recovered yet. If you inflation-adjust, even on single family we’re not there yet.
We’re more affordable now than we were five years ago.”
That affordability is driven in part by lower prices, but it’s also a reflection of three key themes that seem to come up whenever you ask a Calgarian involved in the real estate business about the market: positive net-migration, employment growth and a tight rental market. Despite the persistent weakness in natural gas prices and some high-profile head-office layoffs earlier this year, Calgary continues to attract workers – and high-income ones, at that – from across the country.
The rental market, meanwhile, continues to be the tightest in the country. At a shade above one per cent, Calgary has the lowest vacancy rate in Canada, and the absence of rent controls will mean landlords will continue to raise rents to take advantage of the situation, as they did by an average of seven per cent between April 2012 and April 2013. And with the June floods removing dozens of legal units from the market (and surely more than a few illegal basement suites as well), that rate of increase may look modest by comparison come next April.
Of course, the straw that really stirs the drink right now when it comes to residential real estate (indeed, all real estate) in Canada is record-low interest rates, and in that respect Calgary isn’t different at all. Low interest rates always provide support for real-estate prices, but when they get as low as they’ve been over the last five years they can be a particularly powerful tonic. The math is telling: at three per cent, it only takes 13 months before the majority of a mortgage payment goes towards principal rather than interest. Bump that up to five per cent, though, and it takes 130 months.
That math works both ways, though, as even a return to that five per cent level (which is still relatively low, historically speaking) would add hundreds of dollars to the average homeowner’s mortgage payments when their current rate term expires. Such a move would also turn hundreds of rented out condos that are currently cash-flow positive into a drain on the pocket books of their investor-owners. And remember: this isn’t a question of if rates will increase, but instead of how and when. Combine that with the fact that, according to a study by TransUnion that was released earlier this year, Albertans have an average of $36,223 in non-mortgage debt, the second highest level in the country, and you have an affordability crisis waiting to happen if rates rise fast enough.
Phipps doesn’t see that happening. “I don’t think the rates will change quickly enough to have a huge immediate impact,” he says. “Higher rates are going to hurt some people, and yes, if interest rates go up, we’re going to see gradual price decreases. But I don’t think it’s going to be catastrophic.”
CREB’s Lurie also thinks the odds of a sharp increase in government bond yields and mortgage rates are low. “Am I concerned if it’s a quick increase? Yeah, I’d be a little worried. But I don’t think there’s an incentive to raise interest rates that quickly. Besides, if the economy starts improving and they start raising those interest rates, that should also be an indication that employment and wages are doing better.”
That’s the bullish case. And while it’s more difficult to find anyone willing to put their name to the bearish one, it does exist. It begins with the fact that, after more than a decade of benefiting from two significant tailwinds – falling bond yields and a federal government that was intent on encouraging greater levels of home ownership – those both appear poised to start blowing in the other direction. Indeed, yields rose 100 basis points this past summer alone, a move that amounted to a nearly 40 per cent increase from where they had been sitting earlier in the year. And Finance Minister Jim Flaherty has been clear that his government wants to take some of the heat out of the market, first by reducing the maximum amortization term for government-insured mortgages from 30 to 25 years (it was at 40 as recently as 2008) last year and then restricting the amount of mortgages that CMHC will insure to $350 million. Because Canada’s banks and lenders use that program to securitize the mortgages on their books (which frees up capital that they then use to write new mortgages), its restriction will almost certainly drive up mortgage rates. And if that doesn’t work, it stands to reason that Flaherty may act again – perhaps by increasing the minimum required down payment –to get the soft landing he seems to be looking for.
Then there’s the fact that the sources of Calgary’s economic strength – the jobs and salaries that make housing relatively affordable – rely largely on a single commodity: oil. Yes, the energy sector is more diversified than it was in the early 1980s, when the National Energy Program nearly destroyed the conventional oil business. That diversity may be overstated somewhat, though, given that no matter how it’s produced or which service firms are contracted to help extract it, that oil still gets priced on and traded in the same market.
That’s why, although she’s generally confident in the market’s near-term prospects, the CREB’s Lurie still worries about Calgary’s dependence on oil and gas. “I become concerned if there are issues in the energy sector. I don’t see those right now. Could that change? Absolutely.” And while the odds of oil prices going into the tank may not be very high, there’s not much Calgary can do if that actually happens. There are macroeconomic issues lurking that could conspire to send the global economy back into recession, be it a decision by Congressional Republicans to push their country into default on their debt, an inability on the part of European leaders to defend bond markets in peripheral countries or the Chinese economy slowing down even more than it has.
If that happens, Calgary – and Calgarians – will find themselves dangerously exposed to changing economic conditions, and particularly vulnerable to their knock-on effects. As Re/Max Realtor Troy Weber points out, the city’s relatively high level of home ownership (73 per cent as of the 2011 Census) combined with its relatively low proportion of people who have paid off their mortgage (33 per cent) could spell trouble if market conditions got bad. “We have a huge number of people who own their own home,” he says. “On the one hand, when the economy is really good, that’s a positive thing. The problem with it is if we do see a bubble burst, and a lot of real estate has to come back to the market, then we have a real issue. The amount of homes that would have to go up for sale could really tank our market.”
Finally, there’s the statistical property of regression to the mean. As U.S. economist Robert Schiller demonstrated in a study of home prices that reached back to the late 19th century – and Dutch researcher Piet Eicholz confirmed in a study of house prices along the Herengracht Canal in Amsterdam that dated back to the early 17th century – over time, real prices (that is, adjusted for inflation) tend to be flat. Yes, there will be some variation from the mean from time to time, but in the end it is the mean that always wins out.
Photograph Bryce Meyer
Ben Rabidoux, an economic analyst and the president of North Cove Advisors, pointed this out in a piece he wrote for the Globe and Mail in November 2012. “What these studies tell us is that periods where real house prices are rising – when house prices rise faster than inflation – are invariably followed by periods where real house prices fall,” he said. Calgary’s home prices, for what it’s worth, effectively tracked the rate of inflation between 1973 and 2003. Over the last decade, they’ve doubled – and that with inflation barely averaging two per cent. The problem with waiting for regression to the mean to occur is that even if you believe it must occur, you still have no idea of knowing when it will happen. And as Rabidoux himself suggested, Calgary really is different than markets in the rest of the country – “a different beast altogether,” he said. “Barring a major commodity correction and slowdown in the oil patch, there really is little on the horizon to pressure those markets.”
So who’s right? It depends on who you ask, and what you’re looking at. Doug Whitney, the president of the Canadian Homebuilders’ Association’s Calgary chapter, thinks that uptick in building permits on a year-over-year basis reflects the continued demand for housing – and therefore the likelihood of further price appreciation. “As of the end of August, multi-family permits, which show companies’ intentions to build, had already exceeded the total number taken out for all of 2012, so we are expecting that to result in growth for that segment of the industry next year.” On the other hand, the fact that Calgary saw a 52 per cent decrease year-over-year in residential land purchases could mean developers are hedging their bets, while the increase in subprime lending (up 18.6 per cent nationally, from 10 per cent in 2012) suggests that the big banks are feeling equally nervous about real estate.
And then there’s the fact that a blog dedicated to chronicling the housing bubble in Calgary has essentially gone dead – its last post was on February 3, 2010. Whether that’s a sign of the irrational exuberance that tends to precede the popping of an asset bubble or merely the acceptance of reality is another open question. Weber, for his part, sees a good year ahead for Calgary’s housing market. “My gut tells me that we’re not going to see a huge increase in inventory by the end of the year, so get ready; 2014 is going to be strong – unless somebody goes and uses a nuclear bomb somewhere.”