Rental Market in Canada – Fall 2018

A Falling Vacancy Rate

Once per year, Canada Mortgage and Housing Corporation provides a comprehensive review of rental markets across Canada. The survey occurs during the first half of October. Results for this year were released on November 28.

For October 2018, the vacancy rate was 2.4%, which was a substantial drop from the 3.0% rate recorded a year earlier. The vacancy rate for 2018 is far below the average of 3.3% for the entire period shown in this chart. The reduction in vacancies resulted in more rapid rent increases, at 3.5% this year. Over the entire period shown, the average increase was 2.6%. This data shows that the situation has become increasingly challenging for Canada’s tenants.

 

 

Vacancy rates fell in 7 of the 10 provinces. Manitoba, BC, and Ontario saw small increases in their vacancy rates. These three provinces also saw the most rapid rent increases. The lowest vacancy rate is now in PEI, followed by BC and Ontario. The highest vacancy rates are in the three provinces where economies have been hurt by the plunge in oil prices (Saskatchewan, Newfoundland and Labrador, and Alberta). These provinces saw the weakest rent increases.

 

Interpretation

Since the data is collected only once per year, it is difficult to construct any models for analysis or forecasting of rental markets. The author’s experimentation over many years, for many different communities across Canada, has resulted in statistical models that have low “reliability”. But, those low-reliability results have been surprisingly consistent, and have led to a conclusion: the two most important drivers of changes for the vacancy rate are job creation during the past year (which allows more people to buy or rent housing) and total completions of housing during the past year.It is tempting to expect that completions of new-rental apartments would be important, but the author’s analysis has found that this is rarely the case.

On reflection, this makes sense:

  • The rental market is part of a complex housing system in which there are very large flows between ownership and renting, and between different forms of housing.
  • Expansion of the total stock of housing offers people more choice: even when people move into new home ownership dwellings, that move sets of a chain of other moves. Much of the time, that chain of moves includes someone moving out of a rental, which creates an opportunity for a new tenant.
  • Moreover, the tenure on a new dwelling is not fixed for all time. In particular, it is well known that many new condominium apartments are occupied as rentals. In addition, some low-rise dwellings (single-detached, semi-detached, and town homes) are ostensibly built for ownership but are made available as rentals.

It is also tempting to expect that changes in resale market activity will affect the rental market. But, once again while the statistical analysis produces unreliable results, over many repetitions it has been found that resale activity has little effect on vacancy rates. This also makes sense on reflection. Most of the time a resale transaction does not add to total demand for housing (the buyer usually moves out of a different dwelling) and it usually does not alter the total supply of housing (unless the new buyer adds or removes a basement apartment).

Employment Trends

Our impressions about the employment situation are largely based on data from Statistics Canada’s Labour Force Survey (“LFS”). This data indicates that during the year up to this September, employment in Canada expanded by 1.2%. This is slower than the rate of population growth (1.3%), and this therefore should be considered a mediocre result. Based on this data, we would expect that housing demand would be weak, and the drop in the vacancy rate this year would be a surprise.

However, the data from the LFS is derived from a sample survey and like all such surveys, it can produce errors. Statistics Canada has a second survey (Survey of Employment, Payrolls and Hours, or “SEPH”), which is based on data from employers, and is therefore likely to produce more-accurate data. This data receives much less attention because it is published almost two months after the LFS (the most recent data is for August). The two datasets usually tell similar stories. At present, however, SEPH shows growth of 1.8% (as of August) versus the 1.2% shown by the LFS (as of September).

Over the entire period shown in this chart, job growth averaged 1.5% per year. Strong job growth in both 2017 and 2018 helps to explain the drops in the vacancy rates that were seen in both years. Housing completions were at above average levels during 2017 and 2018 (the chart shows the figures for 12 month periods ending in September). These elevated volumes of new housing supply provided some relief for rental markets. Without this additional housing supply, the drops in the vacancy rates in 2017 and 2018 would have been even larger than they were.

 

Looking Forward

The mortgage stress tests have resulted in reduced buying of new and existing homes. It takes some time for changes in purchases of new homes to translate in reduced housing starts (and even longer for housing completions to be affected). Increasingly, it appears that housing starts have peaked, and may have started to fall. The next chart illustrates that total housing starts were very strong during 2016 and 2017, but the trend has started to fall during 2018. A more detailed examination would show that housing starts have turned sharply for low-rise dwellings (single-detached, semi-detached, and town homes) but remain very strong for apartments. During 2019, starts for apartments will gradually reflect the reductions in sales that have occurred this year. This is explored in more detailed within the Housing Market Digest reports (for Canada and the regions) that can be found here: https://goo.gl/kJ6mcC

Following from these trends for housing starts, housing completions are expected to fall only slightly during the coming year, meaning that new housing supply will continue to provide some relief for the rental sector. However, housing completions are expected to fall considerably during 2020. As for employment, higher interest rates can be expected to gradually weigh on job creation during 2019 and 2020.

For 2019, a combination of continued high levels of housing completions and a slowdown of job creation should mean that there will be little change in the apartment vacancy rate (perhaps a drop to 2.3% from the 2.4% seen in 2018). The low vacancy rate can be expected to result in continued rapid rent increases, at a rate of at least 3%.

During 2020, the reduction of housing completions that will result from the mortgage stress tests will add to pressures in the rental sector. For 2020, the vacancy rate is expected to drop further (approaching 2.0%) and rent increases will quicken.

Government Policies at Cross Purposes

The federal government has announced plans to make major expenditures in support of affordable housing ($40 billion over 10 years). The federally-mandated mortgage stress tests, by reducing movements out of renting, will add to pressures within rental housing markets, and are operating at cross-purposes to the National Housing Strategy.

 

 

 

Disclaimer of Liability

This report has been compiled using data and sources that are believed to be reliable. Mortgage Professionals Canada Inc.
accepts no responsibility for any data or conclusions contained herein. Completed by Will Dunning, November 28, 2018.
Copyright: Mortgage Professionals Canada 2018

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Marion Cook  | November 2018

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Commercial Mortgage Commentary – CMLS Mortgage Analytics Group

Making News

Overnight Rate
In late October, the Bank of Canada (“BOC”) announced the third 25 bps rate hike this year, which brought the overnight target rate to 1.75%. The increase comes after continued strength in economic figures and the negotiation of the “new NAFTA” trade deal with Mexico and the U.S. This pushed the prime rate of major Canadian banks to 3.95%.


GOC Yields
Spread premiums between the Government of Canada (“GOC”) 3, 5, and 10-year term bond yields remain extremely tight. Through Q3/18, the premium between 3-year and 10-year tightened by 4 bps, while the premium between 5-year and 10-year remained unchanged.

Investments
In Q3/18, Telus sold its Vancouver headquarters, Telus Garden, to a partnership of investors represented by Regina-based Greystone Managed Investments for an undisclosed amount. The property was built as a joint-venture by Telus and Westbank Corp. for $750 million and consists of an office tower and residential building in Downtown Vancouver. Telus is expected to generate approximately $170 million in profit on the sale.


Commercial Mortgages

Lenders and borrowers have maintained balanced supply and demand for the 5th straight month with commercial mortgage spreads staying flat. 5-year deals are pricing 145 bps to 160 bps over GOC bonds for top quality assets, while 10-year spreads are pricing at a 10 bps premium for similar risk. The liquidity premium of commercial mortgage spreads over BBBrated corporate bonds remained generally unchanged since our last report with the premium down slightly from 64 bps to 62 bps as a result of a slight increase in corporate spreads. This moves the liquidity premium away from the long-term average of 70 bps.


CMBS

The CMBS market continues to be challenged by unattractive profitability due to tightening commercial mortgage spreads relative to CMBS bonds. Recent weighted average breakeven mortgage spread for new CMBS issuance was approximately 225 bps and with current spreads around 190 bps, the prospects of profitability falls short by 35 bps. Until the commercial mortgage spreads move past the CMBS breakeven point, new issuance activity is expected to be thin.

Senior Unsecured Debt

In Q3/18, senior unsecured debt issuance slowed to $625 million, down from $1.65 billion in Q2/18. However, cumulative 2018 issuance is up 27% on a YTD basis and makes up 86% of the total issuance in 2017. Since our last report, Crombie REIT issued a $75 million, 2.9- year note with a 170 bps spread. Overall, spreads on BBB-rated unsecured debt decreased through Q3/18 to 145 bps. For now, spreads on unsecured REIT debt continue to receive cheaper investor dollars compared to conventional commercial mortgages with a difference of only 10 bps at the end of Q3/18.

CMHC

Spreads on multi-family CMHC-insured loans remained stable since our last report with spreads ranging between 80 bps and 105 bps over GOC on 5-year terms and between 85 bps and 110 bps over GOC on 10-year terms. This is partly due to the relatively unchanged spreads on CMHC-backed Canada Mortgage Bonds (“CMB”). 5-year CMB spreads only decreased 3 bps to 28 bps and the 10-year CMB spreads remained flat between July and September.


High Yield

In Q3/18 the British Columbia Securities Commission (BCSC) announced it will not be renewing the exemption that previously allowed Mortgage Investment Corporations (MICs) to operate in BC without engaging in the onerous registration process with the BCSC. The impact of this announcement will be felt in the local industry as many small MICs will now have to endure registration costs.

ABOUT CMLS MORTGAGE ANALYTICS GROUP
The CMLS Mortgage Analytics Group (“MAG”) is a division of CMLS and the leading provider of independent mortgage valuation, risk ratings, market research and software to the commercial mortgage industry in Canada. Our clients include some of the largest institutional asset managers and insurance companies with assets under management ranging from single digit billions to over $100 billion.