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episode # 299

Inflation, Interest Rate Hikes & the Risks to Vancouver Real Estate w/ John Webster

We are in uncertain times: Inflation is surging, the housing market has been on fire, and experts are calling for as many as EIGHT interest rate hikes in the next two years. So what does this mean for the country’s most expensive real estate market? John Webster, Head of Real Estate Secured Lending and Scotia Mortgage Authority at Scotiabank joins Matt & Adam to cover where we’ve been during covid and, more importantly, where Canadian real estate is heading. Will inflation hit an all time high? What will happen to your carrying costs? And is Scotiabank sounding the alarm? All this and more on today’s info-packed episode!

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Episode Summary


Please tell us about yourself.

In my current role as Head of Real Estate Secured Lending and Scotia Mortgage Authority at Scotiabank, I’m in charge of anything that is secured to a house. I’ve been in the mortgage business for more than 30 years and have seen quite a few markets. But I’ve never seen anything like what we’ve experienced during the pandemic. I had run a few different mortgage businesses before coming to work with Scotiabank about 15 years ago. I’ve seen quite a lot but you’re never too old to see something new.

What drew you to the mortgage business in the first place?

It was a total accident! I’m a lawyer by training and was working full time in politics and government. I was working on a campaign and our group wanted to buy an ad agency. The deal fell through but the people I had signed an agreement with asked me to run a company they had started. As a lawyer, I never closed a mortgage deal but by complete accident I ended up running a mortgage lender. 

Have the last 18 months surprised you?

Very much. There was a lot of pent up demand when we went into the pandemic, which led to high levels of growth. The mortgage business is a proxy for the housing market. And the housing market runs similarly to the growth of the national GDP. The high demand we were seeing was due to low interest rates, high immigration levels leading to new household formations, and the high level of employment. 

New Canadians tend to congregate in the big urban markets and want to become homeowners within a few years of arriving. So that really drives up demand. 

Most of us in the lending world assumed our customers would be displaced during the pandemic and would struggle to meet their obligations. So we set up these big deferral programs. But what happened was an increase in demand. People were working remotely, as many of us still are, which meant they were stuck at home. Many people were unhappy with their living situations, which accelerated demand across many markets. 

With remote work, many people who wanted more space or green space went further afield. Since we couldn’t travel, many people also decided to buy recreational properties. The only market that had a bit of a downturn was the urban condo market as there weren’t international students, no new Canadians immigrating, and people didn’t want to be in the city during the pandemic. But that market has come back. 

Cottage markets saw huge demand and price point acceleration. We also saw people looking at condos for investment purposes since interest rates were so low. The biggest group of people looking to purchase are millennials and they’re concerned with affordability. They want to take advantage of these low interest rates. All of that contributed to record growth in the mortgage business. It was very odd to see a pandemic cause such high growth. 

Our market has been overwhelmingly a seller’s market for quite some time. We’ve been called too frothy for a long time pre-pandemic. 

What’s your take on the Canadian market being called too frothy and the price accelerations we’ve seen?

My take and our take as an institution is that we have not been able to keep up supply to match the demand. We’ve been short 100,000 units per year for the last decade. So we have a big hole to crawl out of. That’s the big cause for increasing price points. 

The international criticism goes back to the Great Depression. A lot of people assumed Canada would see similar issues with mortgage securitization as the US. But the system here, particularly with CMHC, is very different. It’s a world class system that came under a lot of unfair criticism. I’ve spent a lot of time explaining to critics how our market is different from the US’s market. 

People assume our bubble will burst but there’s not a bubble. In Vancouver, you have overwhelming demand and a footprint constrained by the ocean and the mountains. A lot of international buyers are attracted to Vancouver and see that it’s so much cheaper than Singapore, Hong Kong or Sydney. That demand has continued and supply is limited. Vancouver has been slow to increase densification. 

In Canada, we struggle to add density in our urban centres. We need to streamline the approval of new developments for rental, affordable housing and market level housing. All of our jurisdictions have struggled with that. Until all three levels of government get on the same page, we won’t be able to solve the affordability issue.  

What’s your take on the real estate trends we’ve seen develop out of covid? Do these trends have staying power?

I think we’ve already seen a reversion to the mean in regards to the bounce back of the condo market. There was worry in Toronto that all of these units would get dumped onto the market because we didn’t have international students and Airbnb rules were tightened. But that didn’t happen. There’s been a renewed strength of demand in Toronto, and Vancouver as well. 

People will be able to work remotely but even in a hybrid situation, I think you’ll still find people are social animals. They will want to congregate, which we’ve seen in the pandemic reopening. There are also lots of work situations that require being in the same space in person. A lot of industries have been remote for a long time but places like Montreal are back to pre-pandemic commercial real estate vacancy levels. So I think our urban environment will still be dominated by commercial real estate. I think we’ll see a return to pre-pandemic practices.

We’ve heard that lots of people left the big city during the pandemic to move to the Island, the Interior or other small towns. Some of those people may now be rethinking their choice. Is there a risk of a lot of those people being underwater? 

I don’t think so. Some of the biggest gains in price appreciation have been in these smaller communities, like Penticton or other areas in the Interior. That’s taking place across the country. A lot of the population is looking to buy a recreational property or an investment property, so the demand is still there.

The migration to smaller towns was a little overstated in the beginning of the pandemic. In my experience, it was less that people of a working age were moving out of the city and more of an older generation making the move. It was people who had built up equity in their primary residence in a big city who realized they could sell and move further afield. So the people moving were already contemplating retirement or semi-retirement. The pandemic did accelerate things, but not to the levels you might think.

Commuter markets were already seeing huge growth pre-pandemic and that’s where I think more people moved to when they left the city. Plus, a lot of companies are now setting up in these commuter markets where commercial real estate is cheaper and their employees have a chance to buy a home closer to work. 

We’ve heard a lot about the wealth transfer. Can you tell us about that and its impact on the Canadian economy?

Like the pandemic, the wealth transfer has been very uneven. The Bank of Mom and Dad is a real thing but not everyone has access to it. A lot of Boomers are looking at their estate and wanting to pass on their wealth to their kids today so they can use it to buy a home, rather than wait until they pass away. 

My disappointment is that I think we had one of the best first time buyer programs in the world. Unfortunately, the restrictions make it impossible to use in places like Toronto or Vancouver. I think that could be addressed. 

There has also been a lot of expansion in alternative financing. So if you’re a new borrower and don’t qualify at the big banks, there are lots of other forms of financing available. They can be very expensive though and many people who are used to sub 3% interest rates will get sticker shock. 

I tell young people to look at how much they’re paying in rent and see if they can put a third of their income towards buying a home. They’ll also need a contingency fund for leaking roofs and things like that. The great thing about these low rates is that over 60% of your monthly payment goes toward the principal. So you’re creating equity every month. Would you rather be paying that out in rent or realizing the dream of homeownership?

When surveyed, millennials say they want to be homeowners. Canadians have always had a strong desire for homeownership. We’ve also seen older people want to stay in their homes, even though it was predicted that Boomers would all want to sell. So we have millennials getting into their first homes, Boomers staying in their homes and new Canadians coming in looking for homes. All of that contributes to a very strong housing market, even with interest rates rising.

Everyone seems to be talking about inflation. Is inflation transitory or here to stay? How does it impact the real estate market?

The numbers out of the US are the highest rate of inflation in the last 30 years. The Bank of Canada reminded us that transitory doesn’t mean short term. It doesn’t mean this will end in the next month or the next six months. Gas prices, food prices and housing prices have gone up. Because of the pandemic, labour shortages and supply chain disruptions, prices have gone up even further. All of those things create inflation.

So I think you will see inflation and interest rate increases. We think there will be four Bank of Canada increases in 2022 and another four in 2023; so that is a full percentage point per year. We have rates below 2% now but people have to qualify at over 5%. So even with inflation and rates increasing, we have a good cushion and confidence in people’s ability to debt-service. 

I don’t think inflation will dampen housing demand. Maybe if we had a big spike, but no one predicts that. 

It has gotten more expensive and takes longer to build in Vancouver. It’s hard to imagine supply increasing if building costs keep going up.

Building costs have increased but if you look at the lumber swing – last year lumber increased by 6-7% and now it’s come back to earth – but the consumer hasn’t felt that change. Input costs will go up but as the supply chain disruptions are lessened, things will stabilize. 

Materials cost more, it’s impossible to find people to work on your home and there are massive delays. But those things will smooth out over time. However, people should prepare themselves for a rising interest rate market. I think the slope will be steady but gentle.  

We have a client who can lock in at 2.4% for a five year fixed mortgage or 1.6% for a variable mortgage. How can property owners protect themselves against the impact of rising interest rates?

Every borrower is different. If you’re a first time buyer, you may want certainty on your payments. So you may be willing to pay a premium for that certainty. But people who have picked variable over the last several years have come out ahead. Historically, the first choice of Canadians is a five year term. In the pandemic, the majority of people have chosen variable mortgages. 

The great thing about most variable rates is that your payment doesn’t change when the interest rate goes up. Your principal will go down, but the monthly payment doesn’t change. And you can lock into a fixed rate at any time. We even have a program where you can take part of the mortgage at a fixed rate and part at a variable rate. But as a first time buyer, you need to think about how much income you can commit to your housing. 

Going forward, I think you’ll see more people locking into longer terms because of the fear of inflation and rising rates. 

It seems like CMHC famously got the market wrong at the beginning of the pandemic. They seem to still be out of step with other reads on the market. What’s your take on that?

They were a spectacular failure at their ability to predict what was going to happen in the market during the pandemic. Their competitors were delighted by that. But they are a positive voice and important vehicle for affordable housing in this country.

So yes, they were out of step with predicting the market, and I think that was true even before the pandemic. But they’ve done a lot of good. The creation of the Canada mortgage bond was an important thing they did. They’ve added a lot of stability with the support of the government of Canada. They were originally started to help veterans returning from WWII afford housing. I’m hopeful things will get back on track.

What do you think is going to happen in the Vancouver market and the Canadian market overall in the next 1-5 years?

If you look across the country at the major urban markets, they’re all seller’s markets with more demand than supply. I don’t see that changing. I think people’s expectations will have to change. It may not be achievable to live in a single family home in an urban centre. 

Price points will just keep increasing. The question is: How quickly? And will that create a correction? To have a correction you need rapid interest rate increases, high levels of unemployment and decelerating prices. I still see strong high housing demand that will continue. Vancouver will see outsized demand even if the rest of the country decelerates, because of foreign buyers. 

If you’re investing in real estate and you’re worried about a correction, that shouldn’t be your biggest worry. You should be worried about your long term financing. Once we’re into 2022, you should think about locking in your interest rate. 

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