December 16, 2013

U.S. and Canadian housing markets replete with puzzles

The end of 2013 approaches and due to the partial government shutdown in October, one of the most important statistical series on the U.S. economy has still not been updated.

The latest joint press release from the Census Bureau and the Department of Housing and Urban Development, issued on November 26, states that accurate data collection for September and October could not be completed on time.

The starts series for three months — September, October and November — will be released together on December 18.

The latest press release does, however, set out current data on residential building permits.

This provides advance indication of what might be expected from the up-to-date starts series, when it is finally made public.

October’s level of new housing permits was encouragingly high, 1.034 million units seasonally adjusted and annualized (SAAR).

Since the recession, the permits level has exceeded a million units on only one other occasion, in April of this year (1.005 million).

At approximately the same time as the permits bested the one-million-unit benchmark, starts did too — also 1.005 million units SAAR in March.

During the next five months, from April through August, they fell back to an average of 880,000 units.

While the September and October levels of starts will continue to be a puzzle for a while, it can be concluded fairly safely that they will show an improving trend.

As for the regional pattern of permits in October, the percentage changes versus September were led by the West (+15.4%), followed by the South (+9.4%). The Northeast was flat (0.0%) and the Midwest (-9.6%) declined.

Compared with October of last year, the largest percentage gain was recorded by the Northeast (+23.2%), with the West (+17.8%) and South (+14.4%) also showing good gains. The Midwest (+2.6%) lagged.

Permits for single-family properties in October were +6.2% month-to-month and +13.9% year-over-year.

For multi-family units, the comparable figures were +15.3% (m/m) and +22.5% (y/y).

In Canada, housing starts have been holding up well, just under 200,000 units SAAR.

An exceptionally low level of interest rates has kept residential groundbreakings elevated.

But there’s a question mark hanging over the market having to do with mortgage rates.

There’s a specific reason the Minister of Finance is worried and his concern is justified. Will Canadian mortgage holders be able to keep up their payments when yields rise?

The Chairman of the Bank of Canada, Stephen Poloz, has already rejected the notion, but the Organization for Economic Co-operation and Development (OECD) is advocating that Canada consider hiking interest rates as early as next year.

Let me share a personal experience. I bought my first home in the mid-1970s. As the chart below shows, the inflation and mortgage rates were already high at that time (i.e., OPEC was becoming the dominant factor in global oil pricing). Soon afterwards, they shot up more alarmingly.

Knowing that I would soon be forced to renew my mortgage, and very much aware of what was happening with interest rates, it was a scary time. I scrimped and saved and paid down as much of the principal as I could and managed to hang on.

As a conservative financial strategy, that’s what many homeowners should be doing right now.

The chart below is why old-time economists still have residual fears about inflation — although it remains tame for the moment — while “whipper snappers” may be more relaxed on the subject.

I’m not suggesting the early 1980s experience will be repeated anytime soon. But the Bank of Canada will be normalizing its key policy-setting rate in 2015 or 2016. That will mean an upward hike in the “overnight rate” from a current record-low level of 1.00% to at least 3.00%.

The average selling price of an existing home in Canada is $390,000 according to the Canadian Real Estate Association (CREA). Let’s keep the math simple and call the outstanding principle on such a purchase about $300,000.

A mortgage rate increase of 2.00% will add $6,000 to the annual carrying cost. That comes to $500 per month, a not-insubstantial sum of money. It’s the equivalent of buying an extra unwanted mid-size car.

Unless they anticipate the problem and find a way around it, many individuals hobbled with substantial mortgage carrying-cost hikes will find they don’t have money left over to spend on the consumer items they enjoy.

For more articles by Alex Carrick on the Canadian and U.S. economies, please see his market insights. Mr. Carrick also has an economics blog.

History of inflation and 5-year mortgage rate
in Canada, 1951 to present

Data source: Statistics Canada; Chart: Reed Construction Data – CanaData.

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