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Housing Market Calming & Condo Buying Report

June 3, 2013

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Article courtesy of MCAP.

 

Market Calming, Not Crashing: BMO

Bank of Montreal economics published a Special Report last week on the Canadian housing market which seems to provide ample evidence that markets really are in the process of achieving the much sought after “soft landing” after federal policy makers took steps to cool the market last summer. The bank also predicts that the soft landing will likely continue. This analysis is obviously good news for the real estate and mortgage industries in Canada.

There is growing consensus that re-sale transaction volumes have stabilized at levels more in line with historical averages. This means that the drop of about 9% from volumes seen in the first half of 2012 is the new normal level and will likely continue on this pace, after the bite taken by the mortgage rule changes in July of last year. The not-so-good news then is that the pie is clearly smaller and will probably stay smaller for some time.

Housing starts have also adjusted to slowing demand and are now trending at a rate much closer to the rate of household formation – which was and always is inevitable. With a couple of well-known exceptions (like the Toronto condominium market), the bank suggests that, despite the rate of housing starts running well above household formation rates prior to the slowdown, there should be no “material overhang” from the run-up in supply. In certain segments, like the Toronto condo market, excess supply will ultimately bring downward pressure on prices.

Re-sale markets are characterized by the bank as “balanced” and not just in the usual sense of the sales-to-listings ratio being around 50% (which it is) but also with respect to prices and relative ongoing price stability. The Greater Toronto and Vancouver Areas, home to 25% of Canada’s population, may see some “moderate declines” in prices but other regions like Saskatchewan and Alberta should continue to see price appreciation. Overall, prices will be “steadier” this year – and steady prices and valuations are key characteristics of the soft landing seen so far.

 

BMO Condo Buying Report

As part of its Housing Confidence Report, BMO published survey data specific to condominiums last week. The data measures intentions among prospective buyers over the next five years in Canada’s four largest urban markets: Vancouver, Calgary, Toronto and Montreal. Looking first at Vancouver, the intention to buy a condo is down is down 5 points from a year ago to 28% among prospective buyers. The Calgary market reflects the current affordability challenges as condo buying intentions have risen 8 points to 33% while intentions to buy a traditional home have dropped sharply from 71% to 58%. In Toronto, condo buying intentions are up 11 points from last year to 31%. Montreal presents a different scenario where general home buying intentions are up 16 points to 62% but condo buying intentions have fallen by 3points, to 24%.

Demand for condos seems to be growing among baby boomers who might be looking to downsize, decrease home maintenance and increase their sense of security. Condo buying intentions are much higher among those over the age of 50 than they are for those under 50 (30% compared to 17%).

 

Tim

Tim is a mortgage agent in Barrie who specializes in helping first-time home buyers. He works with a variety of lenders and can help customize a mortgage with the best rates & options that fit the needs of each customer.

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Softening House Prices: Silver Linings or Dark Clouds

July 30, 2012

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Article courtesy of MCAP.

 

As housing market data begins to show that prices may be trending a little lower – or at least flat – in some areas in Canada, the debate about the relative benefits or detriments of this new reality has begun in earnest. With new mortgage rules also in place for almost a month now, what does it all mean? If sales fall off and if prices decline, is this a positive development which will position the market for long term stability or will it be another drag on the sputtering economic recovery?

When a leading national realtor publishes its Price Survey and Market Survey Forecast and calls it “Canada’s Housing Market at a Tipping Point”, it’s pretty clear that the trajectory of the real estate market over the past three years is probably not sustainable. Royal Lepage CEO, Phil Soper, a vocal critic of the government’s recent mortgage rule tightening, commented on the data in his company’s report that “home prices cannot grow faster than salaries and the underlying economy indefinitely”. He feels that the market was already cooling when the government tightened mortgage rules, referring to them as “unfortunate”.

Dark CloudsThe Globe and Mail’s personal finance columnist, Rob Carrick, made the case for some of the benefits of price declines in the market in his column last month. Rationality and balance will return to the market, he suggests, and the urgent desire to enter the market for fear of being priced out of it, will subside. But, even if we agree that the pace of price increases could not have continued and that the market needed to cool to preserve its long term stability, what impact could falling house prices have on the Canadian economy?

After enjoying annualized gains averaging 6.2% over the past 10 years, many Canadian home owners are feeling confident in their personal financial circumstances, buoyed by healthy and growing levels of home equity. This confidence continues to fuel consumer spending and keep certain sectors of the economy strong. In the US, prior to the sharp pull-back in the real estate market, the economy was driven largely by the American consumer whose voracious spending was supported by significant gains in home values. When values finally dropped, the American consumer suddenly felt much poorer and then stopped spending. Mr. Carrick suggests that homeowners’ recent gains in Canada will still be solid even if prices were to correct by 10%. This would mean that values would have increased by 5.1% every year, on average, forz the past 10, rather than by 6.2%. While the arithmetic is clear, what isn’t clear is the psychological impact of feeling poorer – even only a bit poorer – on consumer spending. If Canadian households, already under pressure to pay down debt, feel pinched by eroding home equity levels, they could decide to follow a course of household austerity and stop spending. If this happens, the larger economy, including employment growth, will also suffer.

Mr. Carrick points out that first time home buyers, who represent half of the home purchasing market, will enjoy increased affordability if home prices correct. They will be less tempted to stretch the limits of their re-payment capacity in their borrowing and they should be less inclined to succumb to the frenzy of bidding wars for houses. All valid analysis for sure but if the market correction is less orderly and more sudden than expected, first time buyers may be tempted to sit on the sidelines and wait for what they think is the bottom of the market and the end of the correction. Existing homeowners who are both buying and selling need not consider this strategy unless they are purchasing a significantly more expensive home. If enough buyers elect to wait out a correction, the correction itself may be sharper and deeper than expected.

If the market pulls back enough, investors will, once again, be attracted to buy. As Mr. Carrick reminds us, the principle of buying low is still a critical element of any successful investment strategy and, especially in some markets, Canadian residential real estate has not recently presented many opportunities to buy low. Rather, it has created another not so sound investment strategy which says “buy now before prices move even higher”. Few prudent investors follow this approach but it has been a key driver of some of the recent price run-ups in certain hot markets.

The return of rationality to the market would itself be a healthy development. The balance which must be struck in order to create the most beneficial consumer and market perceptions is certainly a challenge. If, as Royal Lepage suggests, the Canadian housing market is at a “tipping point”, the difference between rationality and irrational exuberance may be slim and the risk is that it tips the other way into a correction which is too sharp. If there is a correction in Canadian home values, let’s hope that we realize its benefits without suffering the most severe consequences…

Tim

Tim is a mortgage agent in Barrie who specializes in helping first-time home buyers. He works with a variety of lenders and can help customize a mortgage with the best rates & options that fit the needs of each customer.

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Variable Rate Mortgage Pricing – What in the World is Going On?

April 16, 2012

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Starting four weeks ago, our regularly-scheduled Mortgage Monday blog posts began featuring a 4-part series courtesy of MCAP on how and why mortgages are priced the way they are (the series began with Part 1 four weeks ago: The Bond Market and Fixed Income Yields – How Does it Really Work?, followed by Part 2 three weeks ago: Risk? What Risk? Mortgage Investment From the “Buy Side”, and Part 3 two weeks ago: Fixed Rate Mortgage Pricing – Getting Ahead of the Curve).  We wrap up the 4-part series this week with a look at variable rate mortgage pricing.  If you have some basic financial knowledge, it shouldn’t be overly complex (that being said, these posts aren’t for beginners, either).  Either way, if you have any questions, ask them in the comments below and I’ll do my best to answer them.

 

Part 4 – Variable Rate Mortgage Pricing – What in the World is Going On?

Variable rate mortgages have been very popular for several years in Canada – at times representing up to three quarters of new mortgage production. One reason is the ongoing low rate environment which has made them comparatively cheap. The data shows that they have generally been the better bet as long as borrowers could live with their inherent uncertainty.

The government bond market directly influences the fixed rate mortgage market. The variable rate market moves according to a different set of factors – some well-known and simple; others much more complex and confusing.

First, the simple ones: News organizations widely report on the results of The Bank of Canada’s meetings every six weeks. In these meetings, the bank decides, among others things, on what is known as “The Bank Rate”. The Bank Rate is the rate set for Canadian banks in short term lending to each other. The Bank Rate is currently 1%. Canadian banks widely publish their “Prime Rate” which is generally in the range of 2% above the Bank Rate. The Prime Rate is the rate charged by banks to their best customers for unsecured lines of credit. It also serves as the reference point for other variable rate lending products – like mortgages. The Prime Rate is currently 3%. When the Bank of Canada changes the Bank Rate, Canadian banks change their Prime Rate and pass the changes on to borrowers with variable rate loans.

The Bank Rate has been at 1% and the Prime Rate has been at 3% since May, 2011. But variable rate mortgage pricing has changed considerably in recent months. Why? Lenders have been changing the price (increment or decrement – ie, plus or minus) of variable rate mortgages relative to the Prime Rate. In the last six months, we have seen variable rate mortgages become much more expensive – by about three quarters of a per cent. Why? Well, here is where it gets complicated, convoluted and murky.

Contrary to some theories, there is no conspiracy on the part of the banks to drive consumers into one kind of mortgage product over another. The European debt crisis has washed up on our shores and is the main reason why Canadian lenders have raised variable rate mortgage prices. Very simply, the world’s financial system is fully intertwined and banks borrow from each other all the time. This means that Canadian Banks, while generally not having direct exposure to Greek debt for example, have exposure to other banks which probably do themselves have exposure to debts which may not be fully repaid. Banks around the world find that their “cost of funds” or their price of borrowing from each other has increased. Those increased costs have been passed on to Canadian consumers wanting new variable rate mortgages.

The international financial jitters, like the ones in play now, affect the variable rate market in particular because of their impact on a strategy used by banks called “matching”. In the fixed rate world, traditional banking practice would be to accept 5 year deposits (such as GIC’s), lend those funds in the form of 5 year mortgages, and earn profits on the difference between what is paid on the deposits and what is charged on the mortgages. Maturities (in this case, 5 years) are matched. In the variable rate world, matching is always, not surprisingly, more difficult. The current uncertainty makes matching for variable rate loans even more challenging. The result is higher prices charged to consumers.

There are also new international financial reporting regulations in place which are creating further uncertainty around capital requirements for banks and these are driving costs up as well. Although Canada’s banks are very stable, they are being swept up in the international turmoil – at least in the short term.

We live in a world with one financial system. The fact that increases in variable rate mortgage pricing in Canada are a result of the European debt crisis is the best evidence of this.

Tim

Tim is a mortgage agent in Barrie who specializes in helping first-time home buyers. He works with a variety of lenders and can help customize a mortgage with the best rates & options that fit the needs of each customer.

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Fixed Rate Mortgage Pricing – Getting Ahead of the Curve

April 2, 2012

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Starting two weeks ago and for one more week after today’s post, our regularly-scheduled Mortgage Monday blog posts are featuring a 4-part series courtesy of MCAP on how and why mortgages are priced the way they are (starting with Part 1 two weeks ago: The Bond Market and Fixed Income Yields – How Does it Really Work?, followed by Part 2 last week: Risk? What Risk? Mortgage Investment From the “Buy Side”).  If you have some basic financial knowledge, it shouldn’t be overly complex (that being said, these posts aren’t for beginners, either).  Either way, if you have any questions, ask them in the comments below and I’ll do my best to answer them.

 

Part 3 – Fixed Rate Mortgage Pricing – Getting Ahead of the Curve

Given the three risks associated with mortgages (Credit Risk, Reinvestment Risk and Liquidity Risk), compared to government bonds, what premium or spread above bond yields do investors require? Looking at the popular 5 year term, over the past 10 years, the spread between the 5 year mortgage rate (not the posted rate but the “real” rate) and 5 year government bonds has usually ranged between 100 and 250 basis points or between 1 and 2.5 per cent. Competitive pressures and the desire for market share on the part of some lenders at certain critical times of the year (such as the spring market) can sometimes reduce the spread to below 1 per cent. Conversely, economic uncertainty (such as during the second half of 2008) and the desire on the part of lenders to enhance profitability can stretch the spread towards 3% from time to time. On average, think of the fixed rate spread as being in the range of 150 – 200 basis points or 1.5 to 2 per cent. For the past couple of months, the 5 year Canada bond yield was has been around 1.5 per cent and the average 5 year fixed mortgage rate was around 3.5%, resulting in a spread of about 2%.

Yields in the government bond market are easy to follow. Although yields change second by second when markets are open, checking the 5 year government of Canada bond yield once every business day will connect you to the pulse of the market enough to get a sense of the trends which could result in changes to mortgage rates. If bond prices fall, bond yields rise and spreads are reduced. Increases in mortgage rates are introduced to restore spreads. If bond prices rise, yields fall and spreads increase. This can tempt some lenders to lower mortgage rates to gain short term market share. Usually, the others follow.

We have always heard that fixed rate mortgage pricing is closely tied to the bond market. Now we know how and we also know why. Mortgage originators add value through knowledge, expertise and service. An originator who follows the bond market, can explain to a consumer its relationship to fixed mortgage rates and can foresee possible mortgage rate changes will add to their body of knowledge and can therefore further add value to consumers.

What about variable rate mortgages? The factors which influence their pricing are very different from those which influence fixed rates. Some of these factors are well known like the Bank of Canada’s meeting in a couple of weeks – but what is really going on with the large swings we have seen recently in variable rate mortgage pricing compared to the Prime rate? Find out next Monday as we tackle that issue in the next Mortgage Monday blog post.

Tim

Tim is a mortgage agent in Barrie who specializes in helping first-time home buyers. He works with a variety of lenders and can help customize a mortgage with the best rates & options that fit the needs of each customer.

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The Bond Market and Fixed Income Yields – How Does it Really Work?

March 19, 2012

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This week and for the next several weeks, our regularly-scheduled Mortgage Monday blog posts will feature a 4-part series courtesy of MCAP on how and why mortgages are priced the way they are.  If you have some basic financial knowledge, it shouldn’t be overly complex (that being said, these next couple of posts aren’t for beginners, either).  Either way, if you have any questions, ask them in the comments below and I’ll do my best to answer them.

 

Part 1: The Bond Market and Fixed Income Yields – How Does it Really Work?

The first thing we need to understand about the bond market is the concept of “yield”. The yield of a bond is the income, the earning, the profit – the reason why an investor would invest. With a bond, yield is a function of two things: the interest the bond pays and the price the investor pays for the bond.

Think of this example:

A few years ago, Mary bought a new bond with a face value or principal amount of $100 which pays annual interest of $10. Mary’s yield is 10%. Interest rates in the economy have decreased since Mary bought her bond and, today, a similar new $100 bond only pays annual interest of $5 (a 5% yield). Mary must be happy to have a bond with a yield of 10% when the current yield is now only 5%, right? If Mary decides to sell her bond, she will ask for $200 for it since she knows that investors today are only earning a yield of 5%. Her bond still pays annual interest of $10 to whoever owns it, so the new investor who pays $200 for her bond, will earn a yield of 5%.

Bonds pay a fixed rate of interest until they mature. Bond prices, and therefore bond yields, change all the time.

Have you ever noticed that reporters, when trying to explain the reason why the bond market influences mortgage rates, will often say “because mortgages are financed through the bond market“? Financed through the bond market? While that statement is not entirely true, it can help us understand the relationship between mortgages rates and the bond market.

The bond market (and we are referring to Government of Canada bonds) operates on the simple basis of supply and demand. We have all heard, especially recently, about the government’s operating deficits and overall debt. When the government takes in less than it spends, it finances the shortfall mostly by issuing bonds (and other short term instruments such as Treasury Bills). Investors buy these bonds when they are first issued but there is also a vast secondary market which allows investors to buy and sell existing government bonds before they mature. As with anything in the economy, increased demand results in higher prices. Higher bond prices result in lower bond yields since the interest rate of each bond is fixed when it is issued (like Mary’s example above). Demand for government bonds tends to increase during times of uncertainty and when investors see increased risk in the stock market – like they probably do now. When the economy recovers and the outlook for corporate earnings brightens, investors tend to return to the stock market. Demand for bonds falls off, bond prices are pushed down and bond yields are pushed up.

Government bond yields are widely followed and are used as a reference point or a benchmark for other fixed rate investments. Government bonds are considered to be the safest and the most liquid (easy and fast to sell if necessary) fixed income investments available in Canada. They therefore provide the lowest returns. Other fixed rate investments are evaluated in comparison to government bonds and, since government bonds return the lowest yields, yields on other investments are always higher. The difference is often referred to as the “spread”. Using government bonds as a benchmark therefore provides a base frame of reference for valuation of other fixed rate investments – like mortgages.

Tim

Tim is a mortgage agent in Barrie who specializes in helping first-time home buyers. He works with a variety of lenders and can help customize a mortgage with the best rates & options that fit the needs of each customer.

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