Employment numbers rocking!; Building permits rise on new Ontario condo projects; Big banks begins hiking rates; Ignatieff warns on housing market risks

Employment numbers decidedly above expectation

Expectations of 20,000 new jobs added in January were fully blown out of the water by the 69,000 new jobs added by the Canadian economy.  Very impressive stuff.

If we dig beneath the surface we do discover that while the headline number is still excellent, there are a few facts worth keeping in mind:

  • Employment gains were still led by the public sector.  I question the sustainability of that trend once governments at the provincial and federal levels start dealing with our swollen deficits.  As CIBC noted, “with a gain of 3.4% in the past year (vs. 2.5% for private sector paid jobs) (this) will inevitably come to an end as upcoming federal and provincial budgets turn to fiscal restraint. Note that the narrower category of public administration (which does not include public sector education and health), has ballooned by 5.8% since January 2010.”
  • Nearly 1/3 of the new jobs added were in the self-employed category, a category that can capture those whose unemployment benefits have run out, but who have managed to make some money on the side through their own initiatives.
  • Despite the new jobs, over 106,000 individuals entered the workforce pushing the unemployment rate up 0.2% to 7.8%.
  • Full time jobs are still 100,000 below their pre-recession levels

Employment gains were far from evenly spread across the country with Ontario the big winner and BC the big loser.  As a result, BC’s jobless rate jumped 0.6% to 8.2%, passing Ontario’s jobless rate of 8.1%.

Nonetheless, the private sector job gains alone were greater than the expected total employment gains, making this an overall excellent report.  The Canadian dollar gained on the report, and bonds sold off as the market seemingly sees this report putting additional pressure on Mark Carney to raise interest rates.  The 5 year bond yield, which influences fixed rate mortgages, jumped to the highest level since July 2010.

Building permits rise on new Ontario condo projects

Despite the fact that there are 286 active condo projects in the GTA, representing 73,953 units — the most of any city in North America, evidently we haven’t yet satiated demand for new condos.  Yesterday, Stats Canada released building permit data for December which showed a 2.4% monthly increase.  This increase came after two months of decline, and was driven higher largely by increases in -you guessed it- multi residential development in Ontario.

“Construction intentions for multi-family units increased 55.3% to $1.6 billion in December, the highest level since April 2008. The December advance was due mainly to increases in seven provinces, with Ontario accounting for most of the gain.”

In  2010 alone, over 18,000 condos were started in Toronto….more than double the amount started in 2009.  The pace of condo development in Toronto continues to outpace organic demand via population increase.  It remains supported by the 30-40% investor participation rate in condo sales, with many of these condos being cash flow negative.  One must wonder how long this can possibly go, particularly if the expectation of out-sized capital gains evaporates amid a stagnant or falling market.  My position on the Toronto condo market, the driver of the rise in starts, remains unchanged.

Big banks begin hiking rates

It’s worth reiterating how banks fund their fixed-rate mortgages.

Banks make money by paying interest on deposits and GICs at one rate and then lending it out at another rate.

Suppose someone deposits a bunch of money into a 5 year GIC at a bank. The bank will pay them a couple of percent and then look to make additional money on their deposit. If the 5 year Government of Canada bond yields 7%, would they lend it in a mortgage at 5%? Clearly they would prefer to make the better return by buying the GoC bond.

Bond prices and interest rates are determined in the open market. The BoC has no direct influence over the 5 year bond rate. Therefore, if a bank is considering lending you money for 5 years as a mortgage, they would at least make you pay the same rate they could obtain by purchasing a GoC bond with the same maturity length.

There’s a bit more to it than that, but that’s the basics.  With that in mind let’s have a look at the 5 year bond yield:

That little vertical spike on the right side of the graph indicates that the bond yield of the 5 year bond is rising.  As a result, the banks need to reconsider the interest rate at which they will lend out 5 year mortgages.  And they are reconsidering it:

TD Canada Trust raises mortgage rates

“The bank said that effective Feb. 8, the interest rate on its five-year closed fixed rate mortgage would increases 25 basis points to 5.44%”

All the other big banks will follow suit by the end of the week.

Perhaps the most important interest rate is not the 5 year bond rate but the qualifying rate set by the Bank of Canada.  You may recall that back in April when the new mortgage rules took effect, one of the major rule changes was that all new home buyers had to qualify for their mortgage amount using a new qualifying rate set by the Bank of Canada.  Typically variable rate mortgages are several percent lower than fixed rates, meaning those using variable rate mortgages could traditionally (theoretically) have qualified for a larger mortgage.

Instead, all insured (less than 20% down payment) variable rate mortgages must now be assessed by the banks using the qualifying rate as the minimum.  This rate is set by the Bank of Canada and is updated every Wednesday.  I’d expect the BoC to up their qualification rate tomorrow…..next week at the latest.

This simply means less credit available to new home buyers.  Coupled with the coming changes to max amortizations, a rise in mortgage rates would serve to undercut the flow of credit and new home buyers essential in maintaining house values.


Ignatieff warns on housing market risks

Interesting article from the Calgary Herald over the weekend highlighting comments made by Iggy while in Calgary:

Housing market poised for tumble: Grit leader

“The governor of the Bank of Canada has concerns about the overheating in the housing market. That’s one concern…I have got concerns about an interest rate shock. Consider this one figure: for every dollar that Canadians earn, they owe $1.50. If we have one interest rate shock, a lot of families in Calgary will be under water.”

It’s not just families in Calgary at risk.  Given the asymmetric distribution of debt, that 150% debt level relative to income masks the fact that many families hold significantly more debt than that.  This is true all across the country.  An interest rate shock, which the Bank of Canada continues to warn about, would affect many families all across the country.




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16 Responses to Employment numbers rocking!; Building permits rise on new Ontario condo projects; Big banks begins hiking rates; Ignatieff warns on housing market risks

  1. jesse says:

    “I’d expect the BoC to up their qualification rate tomorrow”

    It wouldn’t surprise me if banks delayed raising their posted rates so as to allow as much qualification under CMHC guidelines as possible before the ominous March deadline.

  2. mac says:

    Ignatieff. Always late to the party.

  3. jesse says:

    “Nearly 1/3 of the new jobs added were in the self-employed category”

    A common trend with larger companies I’m familiar with is to lay off staff and re-hire them on contract. It is typical for these employees to set themselves up as sole proprietorships. It wouldn’t surprise me if the increase in the amt. of workforce declaring as self-employed is simply a result of corporations facing increased benefit and insurance premiums and shortened investment time horizons demanded by investors.

  4. backwardsevolution says:

    “The pace of condo development in Toronto continues to outpace organic demand via population increase. It remains supported by the 30-40% investor participation rate in condo sales, with many of these condos being cash flow negative. One must wonder how long this can possibly go, particularly if the expectation of out-sized capital gains evaporates amid a stagnant or falling market.”

    With a CIBC mortgage, where CIBC gives you cash back to serve as your 5% downpayment and then tacks it onto the end of your mortgage, how much SKIN do these “investors” have in the game? None? And even with this they are cash-flow negative?

    Did they still have to pay a good deal of mortgage insurance, though, if they didn’t have 20% to put down? If they walk away (which they will do), I guess they will lose that money.

    How much do they have to pay for mortgage insurance on, say, a $300,000.00 mortgage?

    Thanks for your great work, Ben.

    • Mango says:

      In Canada you can’t “fence” yourself off and walkaway

      • jesse says:

        In Alberta you can walk away from first mortgages. Beyond that, if you’re a deadbeat like me, who cares about recourse? Squeezing blood from a stone.

        In the US it’s a common misconception that all mortgages are non-recourse. Some states are but many states have both recourse and non-recourse depending on how the contract reads. To wit, Florida is recourse and lo its prices dropped 30%+.

      • Dmitri says:

        Yah… that’s why states with recourse mortgages have some of the highest incidents of ‘jingle mail’.

    • John in Ottawa says:

      I don’t think you can buy a condo “from plans” with a normal 95%/5% cash back from CBIC.

      I bought into 700 Sussex in Ottawa back in 2002. At the time I seem to remember the condo ran about $500,000. I had to lay out about $40,000 immediately and then come up with a total of $120,000 in tranches over the next six months.

      The problem is, these builders can’t get a development loan and break ground until they have a certain percentage of the building sold and a big chunk of cash collected.

      I seem to remember it was about a year later that the builder broke ground and the condo project was about 9 months late. Of course, while all that money was sitting in the builder’s piggy bank, I had to shell out to live somewhere else.

      I’m pretty sure purchasers need to have a good chunk of cash on hand to get in on these deals. I’m just guessing, but I can’t see CIBC lending that chunk of money out for a vacant lot.

      Once the condo is up and running and there is a secondary market, that is probably a different story where CIBC can step in. Some of the investors probably exit as a “flip.” It wasn’t my original intention, but I never did move into Sussex.

  5. Mango says:

    Thank Ben for addressing my recent requests…seems you might actually be getting a touch neutral now? Happy to see you are now not only looking at the “Debt” side but looking at the fantastic job growth and other “income” side factors.

    If I am wrong , then tell me please what your forecast for real estate price drop is?

    • I’m far from bullish Mango. I’ve never advocated an apocalyptic scenario for housing. I see several centres as massively overvalued and likely to experience 50% drops peak-to-trough. I maintain that the possibility is there for a 30% peak-to-trough realignment in national numbers, though the brunt of that pain would be centred in the cities alluded to above, while some centres would fare relatively well.

      Life will go on, but there will be significant pain if this plays out as I see it, particularly as consumer spending reverts back to its long-term mean of 55% GDP. It’s hard not to see a recession if this happens over a short time period. I still maintain that monetary deflation is a bigger threat to the economy than inflation at the moment.

      • Mango says:

        wow, that is bearish.. 50% drops p to t and national 30% drop. Those are numbers out a hat? What annual gross return do you expect from RE???? Let’s start with that and the back test on a graph to at least use a mean reverting argument…

        You are dreaming to get a home at those price levels.

    • vreaa says:

      I’m not apocalyptically inclined either, and agree with Ben’s 50%/30% numbers, perhaps a tad more.
      Apocalyptic would be 80% off a la John Templeton, Danielle Park, et al.

      It is noteworthy that the vast majority of bulls see 15%-off as ‘apocalyptic’ and 25%-off as unthinkable.

  6. Pingback: FI : Employment numbers rocking!; Building permits rise on new Ontario condo projects; Big banks begins hiking rates; Ignatieff warns on housing market risks – 2011-02-08

  7. Pingback: Report highlights from ‘The Current State of Canadian Family Finances’ | Financial Insights

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