Have we found lockdown real estate equilibrium? Covid-19 real estate for York Region, April 24
Saturday Apr 25th, 2020
People seem to get a little bit of value and comfort from these weekly reports, so I'm going to keep doing them until that changes. While it's been interesting to watch things change due to negative impacts of covid-19 and social-distancing policy, the picture is obviously still quite unclear. As you probably know, I interview professionals from the real estate industry on a regular basis. This experience has given me the ability to apply both qualitative and quantitative analysis to what we're seeing happen in real estate.
The qualitative piece gives me some evidence optimistic about, although anecdotal, it seems like a few trends have emerged this week by comparison to last:
- Policy seems to be well regarded as effective in softening the blow of covid, especially on the multi-family residential side as a result of CERB.
- Anticipation is that the 75% rent subsidy could play a similar role in slowing the failure rate of locked-down businesses and keeping retail real estate steady.
- Opportunism seems to be pretty strong on the buy side.
- Volume is down, but hasn't resulted in a meaningful decline in price yet
The way that I like to look at data is through the lens of some of these qualitative assumptions, to see if there's any evidence that these observations might be true.
Here's what I learned about real estate in York Region this week:
Resale house listing and sale prices in York Region:
We've seen a lot of change to volume, but it hasn't really translated so much to price. Where we're seeing average price declining in the GTA, average price is still accelerating in York Region, but median continues its steady decline toward the annual low. Interestingly, listing prices seem to be accurately reflecting sale prices on both the average and median, which tells me that sellers are much more flexible in their reaction to pricing trends than they were in 2017's decline. This would seemingly substantiate the assumption that most believe: people who are selling right now need to sell:
Sale to list price ratio in York Region resale homes:
It's obviously too early in the game to see whether or not things are going to correct, so we can try to use other metrics that have predictive value. The best we've got in this respect is sale to list price ratio (SL ratio) which functionally creates a bid/ask timeline of real estate sales. Discounting in transactions should lead to a discounting in listings. The chart above would prove that to be relatively correct, with listing and sale prices moving in parallel. When we look at discounting, it seems like things have stabilized at 98% from their annual lows of 97%. This seems to be in line with the optimism I've been hearing:
Absorption rate of real estate in York Region
The next metric I'd use to try to anticipate whether or not price has room to decline would be absorption. The clearest way to measure this in layman's terms would be through days on market, which also seems to have rebounded marginally a bit towards a more optimistic scenario. This, in combination with a rebound in SL ratio, would tell me that we've found a temporary equilibrium within a locked-down real estate market:
What risk remains for York Region real estate?
I guess that if I'm implying that things have found a bottom, you'd want to assume that means things should move up from here, but unfortunately I don't think that's the case. A "v-shaped" recovery is unlikely for the economy as a whole, and so a longer-run transaction process like real estate could plausibly move sideways into a U- or L- shaped recovery merely by the nature of its transaction cycle. Here's a quick summary of the risks I've heard talked about, and what the data could us about these things:
Pent-up real estate supply vs. demand
Congruent with the trend of polarity on Twitter, I see a lot of talk about two specific theses:
1. Bear: pent-up supply will cause a supply flood after covid, driving prices down
2. Bull: Pent-up demand will cause a supply shortage after covid, driving prices up
I'm going to play it safe and take the middle ground here and say that honestly, neither are likely. I think that the "wait and see" mentality toward price is going to perpetuate for a while here. Both supply and demand are still trickling into the market and things are transacting. Supply seems to be outpacing demand in the lockdown equilibrium which could soften the impact and likeliness of a supply shock.
York Region real estate sales to new listings ratio in 2020
As a ratio, the above gives us a sales to new listings ratio which looks like this:
Mortgage deferrals and CERB seem to be effective in mitigating the distress right now, so, I think that in the microeconomic outlook, we've found a bit of balance for the time being. I'd still call this a buyer's market, but it's looking a little more balanced. How recovery takes shape, and how the macroeconomic risk factors come to a head, will likely be the deciding factors in how much correction we see in price, and how quickly. Here are a few risks I've seen discussed and my perspective on them.
Increase in power of sales:
I've discussed this at length with a number of very qualified professionals in the lending space. Firstly, people are likely to sell their asset under distress before it gets to the power of sale process, unless we see calling of mortgages and secured revolving credit. Secondly, the reality is that banks do not want to take back properties, and they'll do anything they can to avoid it. CMHC has already made it clear that there's necessity to freeing up cash at the banks by agreeing to purchase billions in insured mortgages. I think that an increase in power of sales is a tough correlation to create with price, because beyond banks not wanting the power of sale themselves, they have to follow a court-ordered price reduction timeline, and are therefore less likely to price discount, at least in the short-term. They're also institutions with analysts and lawyers, and therefore, tougher to negotiate with. Even if we see this happen, it may not be the nail in the coffin that most want it to be.
Decline in immigration:
Immigration is often seen as a big driver of our real estate market. With a tightening global economy and sentiment towards repatriation of supply chains, we could see a decline in foreign direct investment in Canada for the next few years, and that could have a substantial impact on demand.
Beyond commercial assets, immigration drives demand in the housing space, with hundreds of thousands immigrating to Canada annually. Travel restrictions alone could create a meaningful challenge here. Compounding that, lagging growth in the Canadian economy could eliminate the appeal of migration to Canada. The reality of that risk would depend on your outlook on one thing especially - employment.
Lagging employment recovery:
I think this is a very credible risk, and I won't waste your time on diving into what it means. Simply put: less jobs, less credit creation, general economic compression, and smaller capital flows mean less cash to provide upward pressure on the price of real estate.
Essentially, we need to watch for systemic liquidity preference here. If employment leads to a distressed scenario in supply, where vendors are cashing-out of their assets to access liquidity due to economic hardship, this has greater ability to impact the long-term supply, and likely price, than a near-term supply shock, which would really just create a correction.
Given that a household debt is at an all-time high, there is a risk of increased insolvency if asset prices decline substantially and large groups of individuals are looking to access that liquidity while that liquidity is declining proportionate to their asset value. This could create a really dangerous negative feedback loop, which is an important risk to be aware of.