Post-Exodus Real Estate: Liquidity & Sprawl

Thursday Dec 10th, 2020


When you think of real estate development in small towns, what do you imagine? For most investors, large land parcels with massive master-planned communities are the first thing to come to mind. Proportionately, this type of development is responsible for bringing a lot of units to market in the past few market cycles. It may not be especially well-suited to meet the changing demands we've seen in the Greater Toronto Area as a result of the "urban exodus" phenomena I wrote about recently.

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Demand for the detached

The shift in resale demand from density to sprawl in 2020 has been pretty difficult to ignore. Obviously I entered this discussion with a bias toward the suburban landscape, so I've done as much work as I can to try to quantify and verify its existence with data. The major trends are outlined further in my "Urban Exodus" piece, but the general conclusion is that detached demand is heading to 2017 levels, and condo demand is heading in the opposite direction. There's a geographical element to this, as well, in such that demand is shifting more to suburban, and even rural markets. From my perspective, this presents a challenge that we're not necessarily prepared to address, especially if this shift in sentiment is permanent. I don't honestly believe that 100% of the shift in sentiment will be permanent, but I think a good portion of it will.

My major concern with the swiftness of this change in consumer sentiment is that real and sustained. The excess demand is already creating problems in suburban markets, where prices are rising at levels that proved to be unsustainable in 2016-2017. This appears to be happening because you have three major groups of buyers competing for the same detached product:

  1. Boomers - downsizers advancing retirement plans to move into a less urban area;

  2. Millennials - first- or second- time homebuyers advancing upsizing plans to have more space for new household formation and family; and

  3. Investors - looking to capitalize on excess rental demand in suburban markets.

The feeding frenzy created by this competition continues to push prices up. We've seen price growth over 20% in some fringe markets. Historically considered "drive 'til you qualify" areas, many of these markets are seeing their renaissance as cash-flush urban buyers gobble up housing product on the assumption their commuting time may not matter any longer.

Why is this a problem?

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"The range of potential outcomes is enormous" - Ben Rabidoux

When I spoke with Ben Rabidoux on my podcast in early 2020, he stated that "the range of potential outcomes is enormous", and I felt that. Full video of the conversation here:

That being said, I have clients to protect, and I can't really protect them without at least trying to know what's going on. We can't really model for every outcome, but it's worth analyzing things from a best/worst case - as if they could go one of two ways:

  1. Things go back to the way they were before

  2. Things do not go back to the way they were before

Someone smarter than me once said something like "always plan for the worst case, the best case doesn't require a plan." I've found myself examining the range of potential outcomes that rests beyond everything not returning to normal. As a 20-something hobby existentialist, I can honestly say this is the first time I've really felt the practical application of the infinite possibility of the universe.

So, when we think about #1 above, we already know what the world looks like in that scenario. You don't really need to plan for it, you can hope that your mammalian brain returns gracefully to the patterns and habits you operated on just one short year ago. If (it's a huge if) we return to normal as quickly as humanly possible, then the current fire sale on downtown condos should be the best buying opportunity of our lifetime. Full disclosure, I do think there will be a decent buying opportunity for condos in the next 6-12 months. That being said, the lack of opportunists gobbling up that excess supply tells me that's a pretty unlikely scenario. So, what's behind door #2?

This is where we start to uncover that range of potential outcomes that Ben spoke about.

If I'm being honest, today's market isn't really a problem for the average consumer - we've seen hot and bothered market cycles throughout the history of Canadian housing. We've survived them all with bloodshed limited enough that people can easily forget 2017's 30-40% price declines and jump right back into 2020 frenzy. (I'm sure there's a hindsight isn't 2020 joke in here somewhere.) Detached owners are stacking up that precious equity and living up the Canadian dream. When I look at today's housing buyers, especially in fringe markets, I do fear there may be some liquidity concerns on the horizon if demand returns to the urbanized world as promptly as it left.

When you're buying a house in a suburban market in 2020, it feels like a highly liquid product. Supply is tightened because sellers have equity and a relatively forgiving mortgage environment, so there isn't really any need to sell apparent in the market this year. More technically: financial stress hasn't arrived yet as per CMHC's predictions, and the Bank of Canada isn't predicting peak delinquency until Spring of 2021. When you have an excess demand scenario like this, things sell faster, and they sell for more money. That's how supply and demand works. If you want to see what the opposite, excess supply scenario looks like, take a look at downtown condos, as I mentioned above.

Today, if you're buying a house in a fringe market where houses had an average of 30+ days on market in 2019, you'll routinely bump into multiple offers, bidding wars, and sales happening in less than one week. These markets exist, and they're paired with face-ripping price acceleration, too. Don't believe me? Build a time machine and go house shopping in a place like Listowel, Georgina, Muskoka, Kawarthas, most of Durham, Sudbury, Simcoe (the town and the county) etc.

So... why is this a problem? What happens if things go back to normal. This is where you may not want to see things go back to normal, because you care so much about new homeowners and their right to the Canadian dream of infinite equity. What happens if the Bank of Canada is right about peak financial stress and delinquency in Q1-Q2 2021. If you want the easy answer to that question, remember the Bank of Canada is also the entity mainlining liquidity into the market via bond purchases with the Big 6 to keep residential credit flowing. That statement was made in a pre-vaccine pandemic world, as was CMHC's shocking value prediction. Does a vaccine change their assumptions?

Real estate is a long-run supply chain

From my perspective, a bigger challenge faces suburban and rural municipalities if things don't go back to normal - and this is what I plan to do a lot of research about. I've already heard from a handful of planners and municipal governments interested in the data I used to address infrastructure and servicing concerns. The other concern is more challenging, and could actually exacerbate the affordability issues that the exodus has posed to suburban areas. Based on the purchasers above, we could see big changes in the type of product demanded in these municipalities over the next few years, and the supply pipelines are not generally equipped to accommodate because real estate takes a long time to develop.

If you examine the buyers I mentioned above, they're all fighting over similar product, but they don't necessarily want similar product. Boomers may prefer bungalows or large condos because the practicality of stairs is inversely correlated with the passing of time. Investors may want raised bungalows so they can introduce an accessory dwelling unit to get cash positive while they wait for their blessed levered equity bump. Young families would settle for bungalows, but likely wouldn't overpay for them if they can get a suburban 2 storey at a similar price.

The question here is - what are we building today, and does it suit the needs of a post-exodus housing economy? If not, how do we fix it?

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