The arrival of real estate opportunism: May 9 Covid-19 weekly market update

Sunday May 10th, 2020


It seems like we've pretty progressively found a temporary new normal, with little change in most major metrics. The big one to watch for now is going to be price, which could be gradually dragged down by excess supply. In the microeconomic outlook, it appears we're already seeing opportunism propping up the market on a transactional basis, as we've bounced off fundamentals without rebounding from suppressed capitalization rates we saw in the past few years. It seems like there's enough money in the market betting that things will return to normal - so then, what's the risk?

Macro risk for Canadian Real Estate

The looming macro is the big story here. CMHC alludes to the potential for both delinquency and deflation. If realized, these two factors could pose a big threat to the housing market, especially those detached from fundamentals (ie. cash positivity) which is apparent in the GTA condo presale and rental investment markets.

These two risks could be brought on by a handful of macro factors, with employment being the greatest if we see a lower than predicted recovery of lost jobs. (I'll allow you to apply your own investment thesis here.)

Depending on how a reopening looks for these macro factors, we could enter into a negative feedback loop where we see increases in a handful of telling metrics, which we need to pay attention to:

  • Insolvency
  • Delinquency
  • Price change from lowered volume
  • Further discounting from financial stress
  • Organic decrease in immigration
  • Short-term decrease in immigration from travel restrictions
  • Decrease in new household formation

The one saving grace we have here is that while we were on track to see record supply in the Greater Golden Horseshoe this year, this is unlikely now, due to declines in construction productivity. For projects that aren't seeing a liquidity crunch from capital costs, this delay could actually be a good thing. Even in a no-growth environment, units selling with priced-in growth above fair market value are at risk, so time is on the buyers' side here.

In the resale market, things are a little different. I'm going to be honest here, I actually think that a stabilizing market that we're seeing in the short-term may actually be a more negative indicator than a positive one. If we don't see a gradual discounting, it could lead to more abrupt changes as we see the delayed effect of policy running dry. Given the long-run sales cycle of property, this creates exposure to market risk. Keep in mind there are 7 million CERB applicants, courts are closed, and many mortgages are deferred. As a result, it's really tough to get any real information about the macro risk, but one could make assumptions and model them.

This is why I think it's important to see how the microeconomy is behaving, because we can't really operate on live macro data due to lockdown now, but we can work with assumptions. The assumptions and studies I've read allude to an abrupt change in the future, and therefore, it's important to understand how the market looks as we approach it.

York Region Real Estate Absorption:

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Absorption seems to be stabilizing reasonably nicely. We've seen days on market grow to a healthy level for a normal market, but a relatively slow one by recent Canadian standards, which, many would argue, were a problem anyways. If the market stayed the way it was right now, it could create a healthy balance for purchasers marginalized by inaffordability while also creating a slow-burn on on any downard pressure we might see on price. The challenge is that the aforementioned macro risk could throw a wrench into a stabilized market, and I fear that hindsight might tell us that the propped-up market could create a stepping-down of prices, rather than a graduated decline.

On the flipside, the opposite could actually be true for those who believe we may be at risk of a supply flood, as new listings continue to grow, and outpace sales, among a higher-than-average absorption period. What this means is that we could see any supply-shock risk mitigated by a graduated increase from a seller's market to a buyer's market:

York Region Real Estate Listing Inventory & Sales Volume

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Essentially, what this means is that the current gap between listings and sales (better characterized by the SNLR chart below) could get more of those listings onto the market for absorption so that they don't have to enter during a distressed-period, in the event that we see one.

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I feel as though these two factors (absorption and inventory) pretty well balance one another out in the short-term microeconomic outlook. Assuming rational consumers and information, sellers have more to risk here than buyers, if both are behaving as though they believe prices will decline. Sellers also assume more health risk during the transaction process which creates a bit of a conundrum, but that's beside the point.

Ultimately, the deciding factor here will be what the bids in the market look like to demonstrate how volume translates to price.

York Region Real Estate Prices - Sale to List Price Ratio

With above-average relative inventory and below-average relative absorption, buyers will be negotiating for better prices. Conveniently, the SL ratio has stabilized as well. SL ratio tells us how actively sellers are adapting to change in price.

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We've seen the SL ratio recover with stronger correlation to absorption than inventory, we could assume that there is some stability on price within the short-term. The SL ratio seems to be flirting with the 97-98% range, which means that listing prices could come down to match the bids in the fullness of time.

Ultimately, I don't think there is much of a story in the micro yet, but it seems as though things have reached a relative equilibrium with a handful of stimulus present:

  • Canadian Emergency Response Benefit
  • Mortgage deferrals
  • Courts closed
  • CMHC IMPP program

I suspect that we will see more change as these programs start to exhaust, but I don't see the micro giving us much indication of how that change will take shape. I'll still continue reporting in case I'm wrong, but I think the macro risk is the bigger story here, so I'm going to spend a lot more time trying to understand that.

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