BMO Real Estate Forum: BC Outlook
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BMO’s Commercial Real Estate team and industry leaders focus on the BC housing market and virtually discuss regional market trends and economic outlook. Featured panel speakers include:
- Robert Kavcic: Director and Senior Economist, BMO
- Beau Jarvis: President, Wesgroup Properties
- Mike Beg: Senior Vice President and Head, Real Estate Finance, Canadian Commercial Banking, BMO
- Mike Lynch: Regional Vice President, Real Estate Finance, Canadian Commercial Banking, BMO
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Mike Beg: Greetings, everyone. I'm Mike Beg head of BMO's Canadian Commercial Real Estate Finance Team. Thank you all for joining us today. For this event, we are excited to be joined by industry leaders who are actively involved in the Canadian housing market and have perspective on trends and outlook for what's ahead. It's guaranteed to be an informative discussion. We have a lot to cover over the next hour, so I'll walk through the agenda quickly and then we'll get started.
We'll start with Robert Kavcic who will kick us off with an economic update. Regularly, a BMO economics voice in Canadian media, Robert has been with BMO since 2006 and plays a key role in analyzing Canadian regional, economic, fiscal and real estate trends. Following Robert, we'll then have a round table covering key topics and answer questions that were submitted.
For that, we'll be joined by Beau Jarvis president of Wesgroup Properties. He has significant experience in the execution of master plan and mixed-use communities, high and low rise, residential condominium, rental developments, retail, industrial parks, and office buildings. Moderating that discussion is BMO's Mike Lynch. As regional vice president and my BC team leader. He brings 20 years experience in real estate finance overseeing our Vancouver-based BC real estate finance team that manage our complex builder-developer relationships.
Before we get started, if you are watching the event on a desktop or laptop, you will see a chat box next to the video screen. Please feel free to use it at any time during the presentation to submit questions to the panelist. Additionally, below the video screen, you'll see a link to a survey. We welcome your feedback so we can better shape future events like this one. With that, I'll turn it over to you now, Robert.
Robert: Great. Thanks a lot, Mike. Thanks, everyone for coming on. I guess I'll try and set the stage here from a macro perspective before we get into some of the Q&A and more of some of the on-the-ground information that we all want to hear about. What I'm going to do here is just go over the economic outlook, what we see in some areas like inflation and interest rates on the job market. Then specifically what we're seeing in housing which is pretty significant and pretty quick change from what we've been used to through most of the pandemic in that we are finally starting to see some cooling.
First of all, I'll take a look at financial markets. What we've seen is obviously quite a bit of weakness and volatility. Really at the root of everything is central banks' tightening monetary policy. You can see, on the left side there, 10-year treasury yields. They've backed up good full percentage point or so since earlier in the year with tenure us yields trading now up around 3% or so.
That's a pretty big adjustment for asset prices for the economy. Obviously, that has started to filter through into mortgage rates as well. When you look at the growth outlook, we're still looking at pretty solid growth across North America. Growth is slowing down just given some of the headwinds on the inflation front, and we suspect that growth will continue to grind lower through the rest of this year and into 2023 as policy tightens up.
One of the big questions we're getting now is, are we looking at a recession? It's not our base case scenario here obviously. We typically don't forecast recessions. You can see we still have about 3% growth in Canada next year. A little bit under 2% growth in the US next year. Is there a risk that some of these numbers get revised down? I would say yes. We still put a sub 50% probability on recession over the next 12 to 18 months or so.
Clearly, I think the factor that ultimately decides whether or not the cycle runs on is whether or not inflation backs off soon enough for the fed in the bank of Canada to maybe take off some of the pressure and interest rates by the time we get into the early stages of next year. That is really the key that remains to be seen. From a regional perspective, growth looks pretty strong across the country. I think if there's one theme here, it's that we're seeing solid and above potential growth pretty much everywhere in Canada. In BC specifically, we continue to be positive on the province. We usually are one of the banks that does forecast above-average growth for British Columbia, we just think the demographics are strong. The overall industry composition of the province is very strong, and it's going to remain that way. This year, we're looking at 4.4%, a few ticks above the national average.
Next year, we see it roughly around the national average, but still, again, pretty strong running at that 3% or so rate, and probably [inaudible] rate. Then in the job market, I think what we've seen here is a dramatic recovery in labor market conditions, that looks just a lot different than we saw over some of the past cycles.
Just as a quick highlight here, if you look at what has happened with the jobless rate, through this cycle, we've fully recovered within the space of about 18 months. Compare that to what we saw coming out of the US financial crisis back in '08 or '09, where it took the better part of a decade to really tighten up the labor market again. Well, now the job market is extremely tight.
Even across pretty much all of the country and across the vast majority of industries, even within the labor market, we are looking at employment that's back above where we were before the pandemic broke open. You can see British Columbia on top of the list there. That's the strongest job market performance in terms of employment, versus February 2020, or versus pre-COVID levels that we've seen anywhere in the country. The turnaround in employment has been very strong, and we're still very positive on the job market situation.
On the inflation front is where we obviously have some issues still. In Canada, we're looking at just under 7%, year over year, headline inflation. Those are multi-decade highs. Similar in the US, core inflation running just under 4% in Canada, and also multi-decade highs on that front as well. If there's a key feature of this, I would say that sometimes when you see big spikes in inflation like this, it can be driven by just one-off factors like say gas prices jump or insurance costs jump or something like that.
This is different because it's very broad-based across the spectrum of prices. We're seeing food prices rise, gas prices. We're seeing goods prices rise, which, historically, over the last couple of cycles, have not been an issue. Service prices like airfares and really the whole spectrum of the consumer basket is pushing higher right now.
We do have this situation where inflation is pretty widespread and it's pretty persistent. The question we're getting and we're focusing on is when is momentum going to cool. If you look back here at our CPI forecasts, you actually do start to see year-to-year changes in CPI inflation come down. Part of that is base effects.
When we look at underlying momentum on the ground from month to month, or over the last three months or six months, what we actually see is that inflation on an annualized basis is actually holding relatively steady. When we look at core inflation here, we're looking at the US but it's a similar story in Canada, core inflation is running at around 5% or 6% annualized, and that's month after month after a month. We're not seeing a lot of relief here yet.
Where we are seeing maybe a little bit of relief start to show up is in the demand for goods. As consumers rotate out of a lot of spending on goods and things that were consumed around the house, as we're stuck in lockdown in and out of the past three years or so, back into services, we're starting to see some price pressure ease there.
On the housing side, and on the asset price side, we're seeing a little bit of relief there. I'll get into that in a minute. Really across a wide range of other areas like services, agriculture, and resource prices, some supply chain issues that are still hampering the delivery of some goods because of what's happening in China with another round of the pandemic there.
Those pressures are not letting up. We're certainly not see pressure let-up is on the wage side. I mentioned how tight the job market is right now. The reality is that there are a million job vacancies in Canada right now, which is a level we've never seen before.
The longer this persists, and the longer that job market stays tight, the longer that we start to see these inflation rates print, the more and more pressure is going to be put on firms to raise those wages. Employees today have a lot of bargaining power, so there's not going to be a lot of relief on that front at least for the rest of this cycle. Then on the psychology front, you drive by the gas station every day and you've seen big red or orange letters, the price of gas, and that's the fastest way into consumer psychology that we have an inflation issue. When you look at surveyed inflation expectations across various platforms like the University of Michigan or Conference Board, we're pushing multi-decade highs on that front as well.
All this to say and consistent with what we've been saying for a long time that inflation is not going to just magically disappear, it's going to be tamped and backed down by tighter monetary policy. When we look at what the bank of Canada and the federal reserve are doing, we've already seen them come off of zero interest rates and start to tighten. We have a lot more to go, that's the story here.
The bank of Canada, to date, has raised rates 75 basis points. We think you're probably going to see another 50 basis point rate hike next month, 50 basis points following that again in July, and then another 25 basis points later in the fall, so another 125 basis points of the bank of Canada tightening by the end of this year, probably another 50 basis points or so in 2023, and that'll take us to a level that is a little bit higher, about a percentage point higher than we saw at the end of the last cycle for Canadian overnight rates and for Canadian prime rates.
The longer end of the yield curve, you can see, as well, that we've seen rates back up quite a bit. We're probably going to see a little bit more of an upward drift over the next year or so, but, ultimately we have this environment where the market has priced in a lot of what is coming from the Bank of Canada in terms of longer-term interest rates.
Those shorter-term rates and those variable rates are going to be where most of the upside is going forward here. That leaves mortgage rates obviously off the lows already,
but again, consistent with that interest rate forecast headed higher still and quite a bit higher for some parts of the mortgage market. For fixed rates, for now, I think your mileage obviously will vary on this depending on where you're shopping, but, for the most part, we've cracked above 4% for five-year fixed-rate mortgages.
For variable, we seem to be still bouncing around that 2 to 2.25 rate range, but again, you take our Bank of Canada forecast and layer that on, and by the end of this year, you're probably looking at 3.75% to 4% for variable rates, maybe a little bit more upside and fixed rates, but the key message here is that the real estate market is going from being priced at about 1.5% or so, through the course of the pandemic, to very quickly being priced at 4% or so by the end of this year.
That's going to be an issue for the asset price. Is it going to be an issue for the financial stability of Canadian households? I don't think so. Remember, everybody was stress-tested at 5.25% through the pandemic, even though they might have been paying 1.5%. From that perspective, I think the Canadian economy is fine. The financial system is very, very well insulated.
What we have here is an issue of just cleaning some froth out of an asset price that got too far ahead of itself. What we're already starting to see is the market psychology change given that we have seen rates rise and there is a sentiment building out there that the market is softening. When you look at the numbers that we have on the ground as of today, and this is through April, we are pretty clearly seeing signs that the market is softening.
Home sales were down, I think, about 12.5% seasonally adjusted just in April alone. They're still well above where we were pre-COVID, and that just highlights how massive and acute the demand shock in housing was through the pandemic where we were running at about 30% to 50% above what was normal pre-COVID on the demand side of the housing market.
As that comes down, obviously, that's going to take some pressure off of prices and balance out a lot of these markets. You can see, on the right side, where home prices have come from over the past year. I'll just say that this is pretty old news, we're not seeing prices run at a 30% annualized clip anymore. I think that pretty much changed in February, and as the Bank of Canada, again, started to move on rates, the psychology has changed pretty quickly.
There actually are some markets, especially in Ontario that look to be down quite a bit already, and we don't have the official numbers on this, but just anecdotally, I think easily, some areas are already off 10% or 15%. Some markets like on the Prairies and Alberta look quite a bit firmer. British Columbia is, at least from my perspective, somewhere in between where it didn't get quite as frothy as Toronto did, but, clearly there is still a little bit of access to work off of that market as well.
The other thing I'll say here is that, as we maybe start to read more about a possible correction in the price of Canadian housing and maybe even start to see it on the ground, I will just say that, as much as we've been used to this persistent and steady increase in home prices in Canada, the reality is we actually have seen a number of corrections play out over the last 20 or 30 years, across different parts of the country and across different segments of the housing market. In Vancouver specifically, go back to the 1990s, we saw a pretty deep and prolonged correction, even back in 2017, after the bank of Canada started to raise rates, coming out of that energy-induced downturn, BC government also put on a foreign buyer tax. We actually saw this thing that the tax market in Vancouver correct about 13%, 15% or so, took about a year and a half or two to bottom, then really didn't only recover until the pandemic price increases took over about three years or so later.
The point here is twofold. One is that these asset price corrections are not all that uncommon. They do happen. Sometimes they're actually healthy to rebalance the market. The other thing you can see here is that they tend to draw themselves out and they take some time. On average, typically, three years to bottom, five or six years to recover. That's the benchmark with what we've seen historically.
Then the other factor here is if you look, with the exception of Calgary, which is a very oil price-driven market, what is the root cause of these asset price corrections going back? Historically, it's always interest rates. As we already discussed, the interest rate hit to this market is just started. I think there is more coming over the course of this year.
Not to leave a totally negative spin on this, because I do think the housing market is still very well rooted in fundamentals. As I said, this is just the case of cleaning off some of the froth from the asset price. We have two very significant fundamental supports in the market that I think are still going to be with us. One is on the demographic side and one is on the building cost side.
When you look at the demographic situation here, this is 25 to 40-year-old population growth in British Columbia, still growing at about 2% per year. That's a very strong clip. That's a lot of households being created in British Columbia, similar across other parts of the country as well. Whereas, coming from international immigration, everybody knows that, 450,000 people per year, coming into Canada, proportionally, they tend to find their way into the country, roughly equivalent to the population share.
British Columbia is going to get their share of those international immigrants. We all know that, we all see that. Provincial migration is another one where British Columbia has actually started to pull in population from other parts of the country as well. We tend to see fits and starts on this front, but British Columbia is a draw again.
The millennial group is probably what doesn't get enough credit. We've been saying this for probably for 10 years. There's a huge wave of population, the leading edge of which is now in their high 30s. There's about 10 or 15 years of millennials coming behind the leading edge of that wave. When you get into your 30s, you're looking for housing, you're looking for bigger houses, you're looking for single detached houses to put all your kids in.
We are right at the crux of that demographic push right now. That's not going to change. The other thing that's not going to change is on the supply side, where we are building a lot of homes in Canada, but the cost and the rigidities to build those homes are getting significantly tougher.
Couple of things here. One is on the supply side and on the input cost side, we're seeing very significant input cost inflation on the building side. I'm sure Beau will pick up on this in more detail, but just from a macro perspective, if building costs are running at 20% year over year pace, the resale market has run ahead of that, but the resale market can only correct so much before it starts to find a flaw just given what underlying building costs are doing.
I think we will reach that point at some point over the next year or two as that resale price comes down. The other thing here is on the labor side. There's a lot of talk about doubling the pace of housing construction in this country over the next decade. Just physically, it's just going to be so difficult to do, because we are already building a record number of homes in this country. I show that here. There's a record number under construction. When you adjust that on a per capita basis, or however you want to adjust it for the population size, we're still matching the 1970s building boom.
You look at that, you look at a record low jobless rate in the construction sector itself, you look at record high vacancies in the construction sector. A lot of nimbyism like, yes, we can change zoning rules and push them down, but there's still a lot of pushback on that at the local level.
It's just going to be so extremely difficult to actually double the rate of construction in an industry that is already basically operating at full capacity. One of the reasons why we're leaning a little bit more on some of the demand-side measures to cool some of the speculation, some of the froth in these markets is because on the supply side, yes, to everyone's credit, there's a lot we need to accomplish on that front, but in terms of physically just pushing more units onto the market, it's so tough in this kind of economic environment. I think I'll wind it down there so we have some time for more Q&A and some on the ground feedback.
I think the takeaway I'll leave you with here is that the economic situation is still solid. Clearly, it's slowing because there are some challenges out there with inflation at the root of what, what probably will be an bit of an economic slowdown as interest rates rise to combat that inflation. On the house price side, I hope I've made this clear that what we're looking at now is a correction in the froth in the asset price.
Fundamentally, when you look at the demographics and the supply side situation in Canada, we still are very positive on that. We've been positive on that for 10, 15 years, honestly, and we don't think that has changed. Those prices, if they do start to come down in your market specifically as they have in some others already, I think they will find a floor and as we go forward from there, I think, demographically, and on the supply side, we still have a quite a strong housing situation.
I'll leave it at that and I'll turn it over for Q&A and some of the on the ground feedback.
Mike Beg: I think it's over to Michael Lynch at this point.
Mike Lynch: Yes. Thank you, Robert, for your insight and update. We're now going to move into the round table portion of the event. Thank you to all who have submitted questions during registration, we will address as many as possible. Let's get started.
Housing affordability continues to be a contentious topic and a major concern in the Metro Vancouver market with the value of homes at 40%, since COVID 19 pandemic started two years ago, residential rents up 20% year over year in Metro Vancouver, and over 100,000 people migrating to BC in 2021, which is a 40-year record, 33,000 into provincial, and 67 international.
Demand seems to be growing verse contracting, which is not bode well for affordability. While remains to be seen what the effect of the additional government taxes are forecasted interest rates increases will have on the market, it is clear that the main issue to tackle affordability is supply. First question, it will be asked to Beau and Mike. Beau, you can start. What can the various levels of government (federal, provincial, municipal) do to alleviate the supply issues? Further, what can the builders developers do to help with the issue?
Beau: Thanks, Mike. I think the first question, what can various levels of government do to help the supply issue, the simplest thing is they can start collaborating and coordinating policy. I often find it quite amazing. I sat in a round table with a federal member of parliament recently here in Vancouver, and they asked the same question that they asked me two years previous as the question you just asked. All of these levels of government, be it federal-provincial or municipal, pretty much, I would say, number one on their election platforms is housing affordability.
Yet they do not coordinate with one another. CMHC for example, which is a federal body, their policies, they don't coordinate with BC Housing, which is a provincial body here, and both are in the housing game and have mandates by their government to stimulate supply and push funding into the marketplace. CMHC, for example, they require projects to be shovel-ready in order to qualify for their funding programs, but most projects or most land in the lower mainland of British Columbia is not even zoned.
It's as far as an official community plan and we have to take it through rezoning. It creates a timing issue there, but it's just demonstrable of the lack of collaboration and coordination. I think that is the simplest thing that governments can do is start to coordinate. I don't think that they even meet once a month, the various levels of government on housing. It amazes me that that doesn't happen. At least, it wasn't happening last time I was asked this question. I've been banging that drum for quite a while, so perhaps they're starting to meet.
As far as the second part of the question in terms of what developers can do, I think that one of the things that we are doing is trying to educate at and engage in a lot more healthy advocacy through industry associations, such as the Urban Development Institute, which is a significant advocacy group here in the lower mainland of British Columbia and throughout British Columbia. We're establishing really good relationships with various levels of government. I would point to our relationship that we currently have with the Ministry of Housing here, provincially, where there's an unprecedented level of collaboration, and trust-building and we're working with data and factual information such that the minister can understand what the true problems in the market areas such that he can develop and his ministry can develop policy that is going to actually help increase supply in the marketplace.
I think that answers the two questions that you asked. Tell me if I didn't.
Mike Lynch: No, you definitely did. Mike Beg, do you have anything to add to that question at all?
Mike Beg: No, definitely. Thanks to Beau and also thanks to what Robert said on this topic because definitely, in the short run, you know, rising rates can help with affordability challenges when you're experiencing short-run pressures. I think what this question's focused more on is the long-term conditions necessary for affordability and that shifts to long-term supply solutions.
I always think of demand as short-term and supply as a longer-term policy and industry imperative. The Ontario housing task force report that was published in February is a good reference point for me anyway because it's one of the more recent industry reports that's received widespread, I think, recognition from across the country because the issues are somewhat similar.
We did housing affordability somewhat a week or so back and the general view from builders across the country is there's very similar issues. That report said that more housing density was needed across the province of Ontario. All I'd add to that is especially along transit corridors and nodes and infrastructure and retail centers. Density needs to be obviously matched and prioritized to where people live and where they need that density most.
Then the second recommendation of the report was ending exclusionary municipal rules that block or delay new housing. On that one, I'd personally add that if a developer's asked to build below-market housing as a condition of their approval to build market housing, then we need to increase the project density enough that the cost of doing that can be recouped by that builder so that they are not subsidizing something that's uneconomic.
Right now, in major cities like Toronto and Montreal, the builder is forced to pass that cost onto consumers, which only further exacerbates the affordability issues. Cities can't be ostriches with their head in the ground, pretending inclusionary zoning comes for "free." It's a great thing, but it has to be funded, and offering more density to a builder is exactly the right approach because it helps the supply and therefore affordability while keeping the economics incenting builders to keep building.
The other recommendation that report had that I think we should pay attention to across the country is depoliticizing the housing approvals process. I personally extend that to say that counselors and mayors should not be allowed to buy votes by opposing residential developments. Best practices, informed policy, and professional planning expertise, that's really what should be ruling these decisions.
We have to be hard-nosed about that. We can't allow special interests, whether they're local NIMBY interests or maybe small groups of residents who don't want to see a tower in their neighborhood, even though they're living next door to a subway. We can't allow industry special interest to rule. It has to be informed by policy professional planning expertise and best practices around density and approval processes.
Then one of the other report suggestions was preventing abuse of the housing system. I think that that just means that we shouldn't allow people to have their personal mercenary interests get in the way of good planning policy and supply policy.
The last one is interesting because, in our summit, one of our builders made the suggestion that municipal municipalities' access to capital should be tied to some degree to their support for new housing because there are some municipalities that are better at supporting their share of new housing in a region than others. I certainly would go along with that. I think there needs to be a financial incentive for municipalities to build housing that is their share of a broader regional housing supply strategy. The bottom line, in my view, is we need more density and we need faster approvals, and policymakers must remedy both, working with industry in a collaborative way or our supply and affordability channels just will keep recurring, especially during strong periods of demand like we've recently seen coming out of the pandemic.
The last moderate corrections I reference a lot in conversations were in Vancouver and Toronto in 2016 and '17. They were more or less the same, but one year offset. They were followed by two-year dips for buyers to catch up to higher prices, dips in prices and volume, but the bottom and the recovery happened within roughly two years. Now, we're looking at another moderate correction based on what I'm hearing from Robert, hopefully moderate, but it feels like that way. That's barely five or six years later. In my view, a very similar situation if it pans out based on forecast.
Get used to that six-year cycle of moderate corrections and recurring consumer buyer fatigue. That's what a supply and affordability starved housing market looks like over the long haul unless policymakers and builders fix this broken mousetrap with longer-term supply and affordability policies and programs.
As for what builders can do, the one thing I'd focus in on there is that builders that I've seen are starting to get more involved in trying to get access to the trades for youth. One of our builders in Toronto, Tridel, has a program called BOLT, Building Opportunity for Life in the Trades, and they're opening their job sites up to these apprentices to just try and source more labor supply within our housing markets across cities across the country.
Then, of course, that's locally, but we certainly are strong on immigration policy. Why not target a portion of that immigration policy on sourcing trade talent, building talents for the building trades that would help with this supply challenge that Robert alluded to earlier in terms of delivering the product? It's great to have density and housing supply policies that deliver faster approvals, but the industry's got to have the infrastructure to build it.
Anyway, I don't want to run on too long. I probably already have, but that's it for me. Back to you, Mike.
Mike Lynch: Thanks, Mike. Moving on here. The ongoing transformation of the province of BC continues in the face of rising construction and land costs, inflation labor shortages, NIMBYism, ban on foreign purchasers, and unfavorable municipal policies. Beau, this question's to you again. How are developers responding to these constraints and overcoming barriers to entry?
Beau: Thanks, Mike. I think there's a number of aspects to this question. Mike just touched on a lot of things that do answer this question, but I can add to it. Again, I would say that we're getting far more serious about education and being transparent, and we have to. In terms of how we operate in the industry as developers and builders, we're responsible largely for example for building community amenities and infrastructure.
I often say this, that Joe Taxpayer just thinks it's their tax dollars that work, but much of this infrastructure, if not all of it, is financed through development. I think that we just need to get better at educating the public about that, working with politicians to have that conversation, and really be more transparent. That's happening.
With respect to construction costs and land costs and labor shortage and NIMBYism and these types of things, construction and land costs, there's a dynamic that's unfolding now, and I think we'll get into it perhaps a little bit later, but there's a dynamic that's unfolding now that's unprecedented in my mind, or certainly during my career thus far where we have supply shortages that really started prior to COVID. It was exasperated by COVID and now we obviously have a war in Ukraine that has further exasperated the issues. We're seeing dynamics unfold in the marketplace as far as construction costs and construction cost inflation.
It's difficult to understand what's actually taking place such that you can forecast out to understand whether your project is going to be viable or not, and that's across all markets. Residential, merchant, purpose-built rental, industrial, office, retail, et cetera.
As far as the labor shortage - Mike touched on this as well - we have significant aging out of the labor force that we're witnessing right now. We haven't backfilled that. There has been no real acknowledgment that this is going to happen at some point in time. Maybe it's being acknowledged but not acted on such that we're trying to promote the trades. Out of high school and things like that and moving into what we have here in British Columbia's BCIT and into various trades programs and such so that we can backstop that imminent labor shortage. I say imminent, it's already happening, but it's going to get worse.
On the NIMBYism and ban foreign buyer stuff, the NIMBYism - Mike touched on this as well - it's a problem. It's huge. It's been a problem forever. There's this word that's going around or a term that gatekeepers of housing. In that term, local municipal politicians are referenced as well as NIMBYism and people who-- I think there's a statistic out there that, in the city of Vancouver, 80% of the land is owned by about 20% of the population in Vancouver proper, within the boundaries. There's not too many cities where you can drive across the bridge from a downtown core and end up in a single-family neighborhood as soon as you're across the bridge.
We do have those issues here. They continue to persist. That's one of the conversations that we are having with the provincial housing minister. You've seen him come out in the media pretty strong with words against this. He's following up with policy. We have yet to understand what some of that policy will be.
On the foreign purchasers and those types of bands, that's really just almost virtual signaling from the politicians. It's a bit of a myth in terms of how impactful foreign buyers are in our market. For example, if we survey our buyers over the last six or seven years, it's something like 0.7% that we're offshore buyers.
Now, there's certainly some developers that operate in perhaps more of a luxury market or whatever that would have a higher percentage, but when the federal government recently talked about a ban on foreign buyers or attacks or whatever, it's not really impactful to our market and what we're doing here. There's a big conversation about domestic demand. Let me put out a stat here locally that there is, in our market as of September of 2021, $420.6 billion of mortgage-free equity across Metro Vancouver. An interesting component of that statistic is $97.7 billion is aged 75-plus. That wealth is about to transfer, and that transfer creates domestic demand.
I won't get too much more into it, but this foreign buyer tax and this foreign buyer, there's various people who would disagree with me probably, but I think that it hasn't been incredibly impactful in the greater market here in Metro Vancouver, certainly maybe in the luxury market and things like that, but I hope that answers that question.
Mike Lynch: No, absolutely. Good job. Moving on, we've all talked about rising construction costs and how they continue to escalate. Now, for example, a condo, construction hard cost, what it is today is nearly what revenue was a few years ago in that specific area. You talked yesterday, Beau, you had a nice little slide that depicted the issues that the industry's dealing with. Then I think it's good for you to talk about that next.
Beau: Sure. If you could pull up that slide. This is pretty crude for anybody who's watching. I think there are a number of things that are creating construction cost inflations. I alluded to it a little bit. This is drilling into one thing that I think is occurring here, certainly in our local market. I would argue probably across Canada.
I just created this slide, "What is fueling the Fire?" This is a development that we have in New Westminster, which is obviously a local municipality here. If I have my mouse, I don't know if viewers can see this, but this is a sky train station. This is the Royal Columbian Hospital in Sapperton in New Westminster. This is our development, all this, it's a master plan community. This is one of the final buildings. This building here, or the building on the left of the picture that's coming out to the ground, is a condo project that we converted to rental.
It's a purpose-built rental project where the municipality came on board with incentives, including density as Mike alluded to earlier. The federal government came to the table with CMHC financing through the rental construction financing program, and we were a willing private sector participant. A lot of stars were aligned there. It's the poster child for what a lot of certainly various levels of government are talking about for the type of supply that they want to see.
Then on the right side of the image, you see the Royal Columbian Hospital and a $1.2 billion expansion and redevelopment going on there. Both buildings are coming out of the ground at the exact same time. One's provincial, one's private sector. If you zoom back out here in this image, you can see I put a whole bunch of sustainability consultants, mechanical consultants, architects, plumbers, carpenters, city staff approvals. We're all fighting for the same resources to build these projects.
I drove by here the other day, and then I threw a drone up in the air because I thought it was just-- An image is worth a thousand words as they say, and this is just demonstrable of what's adding this fuel to the fire in terms of labor shortage, construction cost, inflation. The various levels of governments are advancing projects at the very same time as the private sector is advancing projects, and we're all fighting for the same resources. This is just a huge, in my mind, contributor to what we're seeing as far as the construction cost inflation as well as-- never mind cost inflation, just simply securing materials. Trying to get your hands on glazing, trying to get your hands on electrical wire and things like that.
It's a pretty big problem. I don't see it changing very quickly. I know that a lot of anecdotal talk on the street here locally is that, there's talk of projects being paused because they're becoming non-viable as a result of costs escalating quicker than revenues, including ourselves. We're currently having some conversations. We have not made any decisions as of yet, but it's certainly something we're looking at. It's not a sustainable environment to operate in, at the current moment in time.
Mike Lynch: Great. Thank you. That was a well-rounded answer for sure. Moving on to the residential market. Vancouver's multi-res market. It's been on a hot streak since COVID, to the acts of COVID. 88% of basically all concrete, wood frame condo, and townhomes, which is 31,000, 35,000 have been absorbed in the market. With respect to the residential rental, the low vacancy rates and insufficient supply have impacted both rents as well as net asset values.
This question goes to Beau and is on a market condo. With condo units in Surrey now selling for close to 1,200 square-foot units, units in New West selling for over 1,000 square-foot, is Metro Vancouver now fully or overpriced? Has it reached its ultimate potential?
Beau: Yes, it's a good question. It's a question that I think we've been asking ourselves here for quite a while. How high can it go? I think sometimes we find ourselves just living in our own box and our own echo chamber here in the Lower Mainland, but when you step outside to places, even other cities within North America or cities around the world, I would say that our prices in some cases are still-- while they're lower than some of those other locations, you think San Francisco, New York, Hong Kong, these types of areas where prices can still-- well, prices are higher for single-family homes for rent and for condominiums.
I love how Robert is very confident in taking a position in the marketplace. I've always been less confident than some of these senior economists in taking a position in the marketplace. I do look at, obviously, the fundamentals, and this has been referred to in this panel's discussion already as far as immigration from both new immigrants to Canada and then BC receiving and Metro Vancouver receiving its share of those immigrants as well as domestic migration. I think it's from-- Since Q2, 2020, we've had about 48,500 people move to BC from within Canada, and that's a staggering number actually.
That's something that we actually don't talk about too much in our market domestically. We continue to focus on the immigration trend. There's a lot of different things going on in those numbers as far as immigration. We hear this number of over 400,000 people coming to Canada a year. While some of those people are already here with student visas or working visas and it's like how many net new warm bodies are coming to Vancouver or coming to Canada, we estimate that about 70,000 people are coming to BC in the next couple, few years that is net new and then you have that domestic migration component.
We build, call 20,000 to 25,000 new housing stats a year. There's a deficiency there that would suggest that, over time, we have a serious imbalance as far as supply and demand. What happens in that situation typically is prices do tend to rise. Now, obviously, there's I believe I agree with Robert in terms of the froth being taken out of the market currently as far as interest rates rising and things like that. Long term, I do think that there's an ability for prices to continue to rise given the aforementioned dynamics.
On the rental side, I see the same thing. I actually would double down on the statement of our rents here locally are low for a similar product in other markets. Now, I can't compare Vancouver to Hong Kong in terms of being a financial center of the world or anything like that. I have to qualify that. I believe we estimate that there's about 12,000 new jobs coming with the various office space that's been absorbed in particular Downtown Vancouver. You have Amazon, you have the Microsoft story. Those are big stories in terms of office absorption.
Those are fairly high-paying jobs too. Anecdotally, I was speaking to someone who just recently preleased a tower on the West End. It was some really high rates that were being leased for. Its obviously Downtown Vancouver West End again. It was a couple, and they had high-paying jobs. They were working for a tech company. They had been relocated here and they paid over $6.20 a square foot for a one-bedroom that had a wonderful view. It was brand new, but that was something that they could afford.
That's a one-off story, but I think that our rents have some space to move yet. Again, we still have historically low rates on rental and we have a supply imbalance there as well. There's a lot of talk politically about all the rental units that have been approved in the last year or two years throughout various municipalities in Lower Mainland. The issue is, the fundamentals or dynamics for rental to be built, they're quite special. The stars need to be aligned. You have interest rates, you have construction costs, you have municipal incentives, federal money, provincial money, all this stuff comes together and rental gets built.
Those dynamics are changing and have been changing for a few months now. Obviously, interest rates are rising which triggers a significantly higher equity requirement in rental projects, and so a lot of those projects that were approved, all of a sudden people are looking at their equity requirement and wondering if it's viable. A lot of these projects are in concrete. While we see a big discrepancy in cost between concrete and wood frame, I would argue that the rental rates aren't too much different. All of a sudden you're going to see a lot of these concrete projects, people asking questions as to whether they have the ability to move forward.
I think, again, creating a supply and demand imbalance where we have all these people moving here. We have all these jobs coming and we need housing. To me, that equals those movement in prices both on the merchant side as well as the purpose-built rental side. I think I was a bit long-winded there. I will shut up. Over to you, Mike.
Mike Lynch: No, you did a great job. I think you covered about three of my questions there, so that's okay. I'm going to throw it to Robert. We talked about rising interest rates, 125 basis points over the next 12 months. Another 50 forecasted in 2023. Has there been any talk that the stress test will be revisited? You mentioned that was amid again of, hey, we've been living under this artificial testing rate for a while and the rates where we are today are not as high as what the testing rate is, so it's not affecting people's affordability or mortgage requirement. Is that going to change with these rising interest rates?
Robert: I don't know if I want to predict what OSFI's going to do on this front. There's been some talk in the media about maybe revisiting the rule, just given that the rule was put in place to insulate the financial system and the economy from a higher interest rate world and now we're going back to that higher interest rate world. If we are back in that world, do we still need a 200 basis point spread up and above what we're paying if we are then in a more neutral environment? That would probably be the justification for easing the stress test if they decide to do that. Again, I'm not really the person to predict whether they will or not.
I guess I will say on this topic that this is one reason why when we talk about the asset price, maybe cooling, we're comfortable with it not spilling over into becoming a bigger issue because the capacity to repay is there. It's there in the job market, they're in the wage pressure, but as I said earlier, everybody who took out 1.5% through the pandemic, they qualified at 525, so there's a lot of buffer there. Even in our rate forecast by the end of this year into early 2023, we're probably looking at 4% on mortgage rates, if you look at, say, the average or variable and fixed. There's still a buffer there that is going to support the economy and support the financial system.
It's interesting now too that if you're going in qualifying for a five-year fixed product, you're qualifying it at 200 basis points spread, so that stress test has actually gotten more stringent as interest rates have backed up. I think that's the calculus they're going to be doing at OSFI, asking whether or not, as we go back to a neutral rate environment, do we still need to tack 200 beeps on to where we're qualifying at? I don't have a prediction, but I think that's what they'll be thinking about.
Mike Lynch: Perfect. Thanks for that insight. I'm going to shift to industrial. That's a sexy topic locally here. Prior to COVID-19, industrial real estate was already a hot commodity. The pandemic accelerated leasing investment and development activity. Global supply chains are under intense pressure, as evident by the record growing cargo volumes at the Port of Metro Vancouver. Consequently, the industrial market remains under intense pressure with low vacancy, growing demand for large bay distribution, and logistics space escalating land and construction prices. Developers are looking for innovative alternatives in order to provide much-needed product into this tight market.
This question goes to Beau. Are the factors responsible for the strong demand sustainable?
Beau: Thanks, Mike. I was, up until about two weeks ago, I wouldn't say generally yes, but my sentiments are changing a little bit. Let's break it down a little bit here as far as the industrial market in the Lower Mainland of BC. We have the mountains, we have the ocean, and we have the agricultural land reserve, so it's really a scarcity issue. We have a huge scarcity of land for industrial in the Lower Mainland. Our industrial rates were single digits across most of the marketplace for a long period of time. At the same time, if you look Southdown Co, Seattle, California, et cetera, you were seeing double-digit rates over the last decade or more. There was this imbalance there.
Then as construction costs started to rise, this was pre-COVID, construction costs had been going up over the last six, seven years, we started to have to raise rates with that. It was okay. Everything was okay. Then along the way, we have this pandemic that hits and everything-- Vacancy rates and industrial were going into the territory of residential, yet all we see is headlines about vacancy rates on residential being sub 1% in many markets. Meanwhile, industrials have been facing the same issues. It's arguably just important because it's job space and it's our goods are being manufactured or transferred through this space.
Through the pandemic, it just got exasperated. Everybody on this panel probably has many boxes at their front door as we're talking on this panel from Amazon. This growth and distribution space has been astronomical, which has put further pressure on the market and so [inaudible] anything, if we're talking about fundamentals, I see that as underpinning the market over the long term.
In the meantime, we're looking at interim measures to be a little bit creative, if you can call industrial creative at all, but it's looking at multi-level warehousing and different things. We have a development under construction that has medium to large bay on the first level, and then on the second level, it has small bays, so you're capturing two markets on one site. I bet you're going to see a lot more of that to try and figure out how we can create more space on the interim, but really, it's a land conversation. I think in the long term, it's a conversation about the agricultural land reserve and how that plays out over the long term.
Anecdotally on the ground, and I said this at the beginning, my sentiment is changing a little bit. We are starting to see some fractures. The strata market was obviously really driving up land prices as well because you could make numbers work by selling off industrial space as opposed to buying the land to build a building and lease it out. That was playing out, but we're starting to see the strata guys pull back a little bit and we're also starting to see tenants have some issues. Perhaps that's as a result of rising interest rates, but I'm seeing different things on the ground start to take place where tenants who committed to significant amounts of space are saying they don't need it anymore and they're putting it out for sublease to mitigate.
We're also seeing some tenants on renewals start to not be able to swallow the market price of that renewal and decide to close down that aspect of their business or that shop and put their resources into other aspects of their business. That's some anecdotal stuff that's going on here locally in the industrial market. That's pretty recent conversations where that's come up. Long term, again, the scarcity issue will persist and will underpin demand, I believe, and that imbalance between supply and demand. Back over to you, Mike.
Mike Lynch: Thank you, Beau. We have about three minutes left, so I'm going to ask the final question, and it'll be back to Beau. What property class will likely offer the best returns of 2022 and beyond?
Beau: Jeez. All right. Mike, I don't even-- It's such a tough-- Again, I wish I was Robert here, such a confident position in the marketplace. It's a tough question to answer, where would I put my money? I mean, I guess I look to residential. I look to the need for housing and the supply and demand imbalance that we've all spoken about over the long term as a result of immigration, domestic migration, and things like that.
If that continues to persist for a significant period of time, which I don't think it's going to sort itself out very quickly, I would argue that having a land bank for residential, whether its purpose-built rental or merchant activity, is one of the best asset classes to be invested in. That said, land can be challenging to hang on to if you don't have some income stream on it, et cetera but I would bet long term on that supply and demand imbalance on the residential side of things, and call it when. I think that's what I would do.
It's a tough question to answer. You could go many ways. I could talk about cap rates coming off on residential purpose-built rental buildings, we could talk about the industrial story, we could talk about office, there's a lot of things there. You could drill into each of them and probably take a position.
Mike Lynch: That's brave of you to say something at all. I like that. Well, I hold you to that. We're going to wrap it up here. thank you again for joining us and taking time out of your busy day. We hope you enjoyed today's session. On behalf of BMO, we want to let we're thinking of you, your families, and your organizations. We're here to help, you bet through uncertain times over more than a 200-year history. We have a strong capital position, and we're well prepared to serve our clients.
Mike Beg
Head, Real Estate Finance
Mike Beg as Head, Real Estate Finance, Canada is responsible for management of BMO’s Commercial Real Estate Finance group and its client relationships across …(..)
View Full Profile >BMO’s Commercial Real Estate team and industry leaders focus on the BC housing market and virtually discuss regional market trends and economic outlook. Featured panel speakers include:
- Robert Kavcic: Director and Senior Economist, BMO
- Beau Jarvis: President, Wesgroup Properties
- Mike Beg: Senior Vice President and Head, Real Estate Finance, Canadian Commercial Banking, BMO
- Mike Lynch: Regional Vice President, Real Estate Finance, Canadian Commercial Banking, BMO
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