Calgary Housing Recovery Already Underway?
It’s been awhile since my last post, so I thought I would share some interesting information.
The first graph illustrates the historical supply and new listings on a seasonally adjusted basis. Sales and new listings have been adjusted on a seasonally adjusted basis so that it gives a leading edge indicator of of how the resale market is performing. For example, December is typically the worst month of the year for sales and May is the best and there is a fairly consistent seasonal pattern to resale volumes. This adjustment also allows one to determine whether price movements are caused to to changes in supply or changes in demand. In the past few years, sales volumes I believe soared well above demographic demand, and in early 2009 were well below demographic demand. I believe future sales volumes will fall moderately from here due to what has been described as demand driven overbuilding (premature buying) that occurred in 2006.
Looking at new listings, one can see that supply is not the problem that many blogs had predicted would happen due to high foreclosures. Supply is much lower than it was in 2007 and 2008 and this is I believe because a much lower percentage of loans was granted to debtors of poor credit quality as compared to the US. I think there is also a rational component to the ebb and flow of activity in the resale market.
The series of events that occurred over the last few years may be as follows…. In 2005\2006 as rental vacancy dropped to 1%, and perceived slowness to bring new product to market, buyers reduced their personal time horizon to buy. This is driven by a belief that if they do not buy now, then they risk further price appreciation occurring or waiting a long time for house prices to drop. Potential sellers also recognize that there is a lack of supply, and put off selling. Speculators also enter the market to drive up demand in the short term, but do not immediately cause an increase in supply. In mid 2007, when inventory is increasing, and new construction was high, it is apparent that supply can satiate demand at that price point. Potential sellers and speculators that were delaying selling rush to the exits to cashout. Also, buyers suddenly realize that there will be a price correction, and now instead of reducing time horizon to buy, they increase the time horizon to buy as they realize that in the near term there was going to be a price correction. This causes a very sharp and sudden shift in both the supply and demand balance. In 2009, when housing construction nearly ground to a halt (especially with MFH starts) buyers have now begun reentering the market once again as inventory depletes. Potential sellers may also now be once again delaying selling purchases due to perception that the market has turned the corner, and less risk from a wave of supply coming from foreclosures.
In summary, I believe the price correction in the resale market is over for now as indicated by the graphs below… Although, I do not see why a relapse into a bear market is not possible if sales were to drop again. Housing corrections typically occur over a period of several years, and historically taken at least 4 years to unwind so I would not be surprised to see further price drops if the supply\demand situation shifts once again. There are reports that the Calgary commercial office space is overbuilt and vacancies will rise to 20% in the coming years and will halt commercial construction in Calgary for several years. The good news is this will provide stability and growth opportunity for businesses in Calgary as they can better keep a lid on operating costs.
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Calgary Econometric Rent Model
There are really three separate, but linked, real estate markets: the resale market, the new construction market and the rental market. The following graph shows the historic relationship (1973-2008) between vacancy rates and rental increases for Calgary and has a good correlation of R²=0.80.
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Source: CMHC Rental Market Statistics, UBC Centre for Urban Economics and Real Estate
Inventory Zenith
As discussed in a previous post, leading indicators at that time had pointed to the balance of inventory tipping towards excess demand in the near term. That has now happened, and year over year inventory is down 7% in Calgary.
The following graph illustrates a potential medium term price point. It is based on two points wherein inventory was dropping on a year over year basis. Prices dramatically above these points may lead to excess supply, and prices below have tended to lead to excess demand.
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Also noteworthy is:
- Wave of speculators in 2006 & 2007 resale market now appears to be over and unlikely to be a source of supply for some time.
- Calgary single family home construction was the lowest since 1995 in 2008 and the low level of housing starts is expected to continue into 2009. This is lower than demographic growth and therefore resale inventory appears poised to continue siphoning off from it’s current high levels.
- Drop in interest rates is likely having an impact on inventory. As interest rates drop, the yield spread between rent and mortgage rates improves thus increasing affordability and relative investment value. Some investors and homeowners may choose to delist if they believe their is more value in renting, or that the resale market is likely selling at a bigger discount to the new home construction market. New construction inventory may not be able to be supplied at the current price point. Note: Buyers need to run various budget scenarios to determine the risk of rising interest rates.
- Mortgage arrears in Alberta, while expected to rise, are at cyclical averages. Mike Fotiou, at First Place Realty, lists approximately 2.3% of inventory on the market as a foreclosure or judicial sale. This contrasts to the situation in the United States where 45% of sales are distressed properties. Canadian banks had argued that only 5.4% of Canadian mortgage market originations were nonconforming, compared to 33% of the market in the US was subprime and Alt-A. To date, the reduced exposure to shady loan origination practices in Canada appears to have largely insulated our housing market from the same level of credit defaults. As in the US, the extent of credit defaults will not be fully understood until house prices find a bottom. As year over year inventory is already dropping, this does not seem to be a large source of supply.
- Absorption rate is a source of imperfect information that may results in real estate mispricing. For instance, the absorption rate was 3.1 at the peak of the market in July 2007 and could have been perceived as a ‘good time to buy’ or ‘balanced market.’ However, year over year inventory increases were greater than 100% at the time and should have been an extremely strong indication that the market was about to correct. I think that absorption rate provides a good estimation of how the market will behave in the near term. However, a comparison of year over year inventory changes may provide a better estimate of how the market will behave in the medium term.
Sources: Bob Truman – First Place Realty, Mike Fotiou -First Place Realty, CREB, CIBC, Bloomberg
Random Thoughts on Oil and Multiple Equilibria Supply/Demand Points
Oil prices have tumbled dramatically from $147.27 on July 11, 2008 to $38.00 on February 23, 2009. Many experts have weighed in that oil prices were a speculative bubble. The rationale for higher oil prices stemmed from emerging demand from China and India, coupled with oil supply being relatively flat in response to higher and higher prices and was featured in a number of bullish economic reports, most notably Merrill Lynch and CIBC.
Since then, oil demand has dropped, and oil prices have declined. Small changes in supply/demand dramatically impact price, (e.g. consumption is down ~5%, yet prices are down more considerably). Petroleum product infrastructure has been designed for transportation and piping, not storage.
There is a fat tail risk for energy company bankruptcies. Companies that expanded and acquired heavily and drilled many new wells in a high commodity price environment, may no longer payback the original capital investment borrowed due to poor netbacks. AJM, McDaniel, Sproule have price decks that result in higher asset valuations, due to oil contango but this is based on a paper valuation that I do not believe fully reflects that the global economy has entered the worst economic recession since World War II. It may take 2 years to determine bankrupt energy companies from healthy ones as future oil barrels have a high degree of price uncertainty. The following quickie back of the envelope economics illustrates the difficult economic hurdles the Alberta energy industry currently faces:
Alberta Back of The Envelope Oil Economics
Average new oil well drill production: Assume 28.3 bbl/oil
Average annual decline: 18% year over year
Average well reserves estimate: 41,300 bbl (as calculated)
Well Cost Estimate: $1,000,000
Tie-In and Facility Cost: $300,000 (estimated average cost per success well)
Edmonton Par: $46.40/bbl
Finding & Development Cost: $31/bbl (as calculated above)
Operating Costs: $14/bbl (estimated based on companies such as Pengrowth and Husky)
Royalties (estimated 20%): $9/bbl
Plus corporate economic hurdle = You Do The Math!
In general, prices are high enough to cover operating costs, but not enough for capital investments. For the most part, the stock market is very focused on earnings growth and therefore rate is king. Bondholders require coupon payments, and therefore shutting in production to increase asset value may not be an option due to high debt loads.
When demand increases, there could be a second oil price shock resulting in yet more economic turmoil. Prices could rapidly climb as current prices are more reflective of operating costs, and would need to shift upward substantially to incorporate finding and development costs and adequately compensate investors (shift in supply/demand equilibria point).
It is likely less expensive to increase production through acquisitions than drilling. A well capitalized energy company could evaluate shutting in production to increase asset value (as in general, prices are too low to drill), and use existing cash reserves to acquire depressed natural resource assets.
Dichotomous Marketplaces – Calgary Trends in Construction for SFH diverge from Resale Market
The new home construction market has shifted in comparison to the resale market. The new house price index for Calgary continued to rise into 2008 as compared to the resale market which peaked in 2007. The new house price index for Calgary has only recently had a year over year decline and as of October 2008 had declined by 1.6%. Against this price backdrop, single family home starts dropped 44% against a 29% drop in sales. Also, there was a large shift towards higher end houses in Calgary and the top end of the market experienced large sales growth. SFH units under construction have retreated to 2001 levels.
It is possible that participants from both marketplaces may find opportunity in new places for 2009. Builder’s may find less demand for high-end houses due to the slump in stock prices greatly affecting the wealthier class. The resale market may experience less new listings due to less people buying new at the top of the real estate pyramid. People looking to buy at below $350,000 may find that the best source of supply is in the resale market.
Below is a table of changes in the new SFH market that occurred over the last year:
CMHC housing information available here.
Glut Today, Excess Demand Tomorrow
A review of inventory trends and prices is useful for helping to understand what the future price trend will be for the Calgary market. From the following graph, some conclusions can be made:
- Falling levels of inventory generally lead to higher prices and vice versa.
- Inventory is dropping at the fastest rate since the Spring 2006 bull market rally. Inventory has fallen 41% since the peak inventory in May 2008 to December 2008.
- Inventory rose most dramatically in 2006, by a smaller amount in 2007, and even smaller amount in 2008. The implications is that resale inventory appears poised to fall on a year over year basis for 2009. As of September 2008, single family home housing starts are at the lowest levels since 1986.
- Recent major market events including the oil price decline, and Lehman Brothers bank failure have not increased inventory levels.
- Major sources of supply were in response to high prices, not foreclosures; that source of supply now appears to be tapped out.
- Calgary real estate market has crossed into a state of excess demand, after several years of excess supply.
- Current high levels of inventory require risk management to bring inventory in with long term trends.
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Data: CREB, Bob Truman – First Place Realty
The Price is Not Right… (But Not by Much)
In 2005 and 2006 supply was much less than demand and house prices rose. A ratio of 50% sales to new listings ratio has historically kept prices in balance. House prices overshot the supply/demand balance and started to fall. The crossover of the supply/demand balance indicates a level of price support at ~$375,000. Demand is likely to rebound slowly as prices drop. Supply is likely to retrace the supply/price relationship. As illustrated below, some overshoot to the downside is likely to burn through the current inventory.
Of particular interest is that supply had a high degree of elasticity in respect to price whereas sales did not. As a corollorary, I think that to some extent:
- Supply = f(marginal cost of supply), linear relationship
- Demand = f(consumer confidence), nonlinear relationship
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Data: Bob Truman, First Place Realty – Old Criteria
A Tale of Two Markets
A split has occurred in regards to the single family home and multi family home construction environment. The following article address the differences in supply-side characteristics for each market.
Calgary single family home market:
- Correction in starts largely historical, capacity to overbuild looks minimal, last couple data points may point to a bottom approaching as housing construction returns to historical rates, orderly unwinding likely
Calgary multi family home market:
- Construction has continued unabated, capacity to overbuild in place, projects such as Gateway Midtown being suspended point to major trouble signs ahead, long way to drop for construction starts to return to historical rates, disorderly unwinding possible
Calgary Real Estate Price Elasticity of Supply
The supply of residential construction in Calgary has been tightly correlated with house prices over the past 30+ years. High house prices lead to high levels of residential construction as increased margins encourage more market participants.
The following graph compares the amount of units under construction to house prices:
I believe this graph demonstrates that the Calgary real estate market is capable of oversupplying the market at the current price point and will continue to do so until developers margins are thinner. Feel free to post your own interpretation below.
Condo Crazy
There are massive levels of new construction about to hit the condo market. There are a record 3,000+ condo units for sale in the resale market. This is relatively small in comparison to the whopping 20,000+ multi-family residential units that are in construction, approved or proposed for Calgary.
The following mosaic and slideshow was compiled based on condo construction due for Calgary.
Hat tip to Boris2K7 for providing detailed information on the Calgary Construction Forum.
