Moody’s Analytics is known for its deep risk expertise when analyzing global markets. What does Moody’s Canadian expert economist think of our country’s housing markets and Vancouver more specifically? Brendan LaCerda joins Adam & Matt to discuss present risks and future outlooks for Canadian real estate as well as larger global trends that will impact your portfolio. Listen up!
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Brendan is an economist with Moody’s Analytics. He is the economic forecasting lead for its Canadian national and subnational service. This involves global model development and building. Having grown up in Boston, Brendan had to learn the Canadian economy pretty quickly when he started the job.
There is an advantage to not being from Canada, as Brendan is objective and agnostic in his approach. The forecasts do reflect cultural and political differences at times, but a lot of this is built into the structure of the economy. For instance, delinquencies in mortgages are still several times higher in the US than in Canada (though they have been decreasing).
On the health of the Canadian economy:
It’s in good shape. There was a roller coaster when oil prices came down. Things were bleak in 2015 and the first half of 2016. Then, there was phenomenal growth and now we’re cruising and on target for the long-run potential growth rate. If Brendan was worried about any particular year, it would be 2020: interest rates will be much higher, and households will have a lot of debt. This is because of the US and spillover effects to Canada. Trump’s tax cut package has all the cuts front-loaded in 2018 and 2019, and there is a boost in federal spending on top of that. So, tax rates rise, and we will lose the stimulus in 2020. Instead, interest rates will continue to rise along with inflation.
On the biggest risk factor Canada faces as we move towards 2020:
There is the issue of debt; in Canada, particularly mortgage debt (though this is an issue worldwide). Another risk is the trade front. Canada’s economy is open and depends heavily on trade. Despite some certainty with the USMCA agreement, the conflict between US and China has slowed growth in China, which is a big market for Canadian exports. This has caused commodity prices to fall, which impairs income growth for businesses. This is 100% politics and deliberate policy decisions. There is no overwhelming economic reason that justifies them, which makes economists’ jobs difficult because you can’t forecast and read policy makers’ minds. Most economists believe trade is positive, so it’s unfortunate to move backwards. However, it’s policy-driven decisions, so this could change with the next administration.
On Canadians’ mortgage debt, how it compares historically, and where we’re headed:
Brendan looks at total household credit as a fraction of disposable income: how much Canadians borrow relative to how much they make. This ratio is up to at least 170%, which is double what it was 20 years ago. The 2007-2009 recession was much milder in Canada than the rest of the world, but policy makers brought interest rates down close to 0% (and in some countries, they are negative), which made borrowing extremely cheap. Besides mortgage debt, governments worldwide have piled up public debt. China has taken on a lot of corporate debt. This decade of very low rates has sparked a lot of borrowing, worldwide.
On the de-leveraging process:
If we can achieve a soft landing, we’d have central banks slowly raising interest rates that curb growth in credit. Meanwhile, labour markets are in great shape and wages increase. If we can hold this together, income gains will help households, government, and businesses get in a better position. It will take time and we are in a precarious position. The debt alone will not spark a recession, nor will rising interest rates or a severe contraction in the housing market. The bedrock is the labour market—it needs to hold together and create income gains to reduce debt. The concern is something may develop in, say, the financial market or trade that causes erosion in the labour market—this would be more pronounced de-leveraging and a vicious cycle of job losses and cutbacks, and it’s how you end up in a recession.
On areas of Canada at the highest risk:
Each region has its own particular risks. Certain areas, such as the Prairies and Atlantic provinces, are heavily dependent on commodity prices. Ontario is more affected by the financial services industry and trade. BC is exposed to trade and the housing market; so much of Vancouver’s economy is devoted to home building.
However, Moody’s does not envision a severe correction in the housing market, nor are they predicting a recession in the next three years. Prospects have improved on the trade front.
On if Vancouver’s housing market is a bubble:
Brendan would not deem our housing market a bubble—if it were, it would have to pop. Everyone defines a “bubble” differently, so he does not like to use the term. House prices have deviated from long-run fundamentals of median household income growth, population growth, and land prices. Moody’s first considers what determines the long-run trend, and then constructs a second equation for how the market can vary from that trend (which depends on high frequency indicators like unemployment and mortgage rates). The Vancouver real estate market is overvalued by about 40%, but we won’t see a correction this high. Moody’s forecast is prices will level off and the trend will catch up.
On the fundamentals of local markets and if they are still useful:
There is a huge amount of global capital. It’s not a coincidence that Vancouver’s and Toronto’s housing markets took off in 2015. Over three years with the fall of oil prices, the Canadian dollar went down by 25%. For foreign investors in 2015-2016, Canadian real estate became a much more attractive investment. In US dollars, you don’t see the bubble people refer to.
On Vancouver within the global context and if it’s a “superstar” city:
It’s rising in the rankings; its global profile has increased a lot. In cities like London, Tokyo, and Hong Kong, there are global financial centres so a lot of money flows into them. A lot of foreign demand helped push up prices in Vancouver. This is not likely to happen again (i.e. our dollar won’t drop another 25%). As growth has slowed, these countries have tightened up on capital controls and don’t let as much money leave the country. Caution is warranted as to how much money will flow into Vancouver. The attraction might be that house prices on the US west coast are blowing up (e.g. L.A., San Francisco, Seattle); in this respect, Vancouver is more affordable. Canada has a more liberal immigration policy. We are headed in the direction of these other cities; tourism is growing. But there is still a long way to go.
On if the Vancouver market will be flat for some time:
Regarding the previous run-up in prices, there was a perfect storm or confluence of events with strong global growth, the fall of the Canadian dollar, and extremely low interest rates to boost prices. Going forward, Brendan is looking at different fundamentals that will dictate where the market’s headed. There are almost two markets. The single-family and single-family attached, which will do fairly well with forecasted growth of 4-5% over the next two years. In the multi-family condo market, a huge amount of new supply is coming up. The number of completions as a ratio of population growth is very high. Recently, housing starts have pulled back, but dollar values continue to skyrocket, which suggests large investment in the luxury, high-end market. However, interest rates cool down demand so there will be a significant correction to the apartment and condo market. Qualitatively, Vancouver is a great place to live and values could be affected by this desire of many people.
On people hedging against global warming:
Moody’s has done some research on how global warming affects rising sea levels and which global metro areas would be most threatened, but nothing specific for Vancouver. There is a shortage of land in Vancouver, especially as people want to live closer to downtown. This is a constraint and is what lends a lot of support to the single-family market—the land these homes sit on is very valuable. On the other hand, the land values of multi-family developments are more threatened by cyclical events in the economy.
On which North American markets have real room to grow:
Businesses, over the long run, are more attracted to lower cost areas with highly skilled workforces. Moody’s expects strong growth in the American Rocky Mountain region – places like Denver and Salt Lake City have rapidly expanding economies and population growth. Canada benefits too with a highly skilled workforce and liberal immigration policy, which will encourage population growth. At some point it gets discouraging for people – factors like unaffordable areas and being in early stages of their careers. This was the story of Seattle before Amazon propelled the city. Portland and Eugene, Oregon have seen a lot of growth, previously because of their affordability.
On whether Brendan will have a lifelong connection to Canada:
Brendan has really enjoyed his time in the Vancouver area (he loved the Capilano suspension bridge). As an economist, you dig down and look at differences of places. When you cover a country different than your own, you start to see how cultural institutions and legal systems differ and the economic outcomes of those differences. Brendan’s opinion of Canada has only improved.
To find out more about Brendan and Moody’s Analytics: