Understanding inflation measurement and housing
There has been a lot of confusion about inflation and the housing market in the past year. How could it be that average home prices are up 18% year over year while inflation is only 3.1% as of the June figure? This has lead to lots of bad takes online, including everything up to the theory that the CPI is a manipulated tool the government uses for financial suppression.
Inflation has been running a little hot lately, with the latest reading of 3.1% above the official 2% target. But as with real estate, to understand what’s going on, you first want to zoom out to put the data into context. In this case much of the higher than average inflation was just getting us back to the pre-COVID trend. We should expect inflation to run hot for some time as demand shocks continue to ripple around the world and run into simultaneous supply chain disruptions, but it’s far from a foregone conclusion that we’re in for a period of sustained high inflation. At this point inflation is not unusual, but the future is anyone’s guess.
What is the CPI anyway?
The Consumer Price Index is the primary measure used to track inflation in Canada. How it works in short is that Statistics Canada looks at the average spending patterns of Canadians, then constructs a basket of goods to closely match what people buy. Then it tracks the price changes of those things over time, adjusting for changes in quantity (shrinkflation) and quality as products change. There’s more to it of course, but that’s the basics.
As you can imagine, the pandemic threw a wrench into the relatively predictable spending patterns of Canadians. CPI weights were recently adjusted to reflect the change in spending, and the weights shifted more than usual, with the proportion of spending on transportation and recreation dropping while shelter and household spending gained substantially as a percentage of totals. As spending patterns return to normal (and we see some catch up spending in travel & recreation), the CPI weights will likely diverge more than usual from actual spending until they are adjusted again. In other words, expect CPI to be a little wacky for some time to come.
It’s important to remember that the CPI is based on average spending of all Canadians, which means you shouldn’t expect it to accurately reflect inflation for yourself. The CPI is a mix of costs for renters, owners, those living in a cabin in Tumbler Ridge or a condo in Toronto. If you want to get an estimate of your own inflation rate, they provide a handy personal inflation calculator that can estimate it given your spending patterns.
How does the CPI measure housing costs?
The shelter component is the largest single component of the CPI which reflects it’s relative importance in terms of what people spend. The measurement of rent is fairly straightforward. Statscan asks a subset of the respondents of the Labour Force Survey about what they are paying in rent as well as the characteristics of their dwelling, and then they derive the change in rents from those responses (about 9000 per month). Something worth remembering here is that this is a sample of all renters including those that have been in their homes for a long time and are paying substantially below market rents. Rent controls usually protect existing tenants from steep increases, but in tight rental markets people who move will experience an inflationary shock in the form of steep rent increases.
For owned housing, which represents 19.73% of the basket for BC, the index is calculated as in the following table. Most of the line items are self explanatory, other than replacement cost which tracks the change in the price of new housing to capture housing replacement (more on this later).
| Component | Weight |
|---|---|
| Replacement cost | 5.61% |
| Property taxes and other special charges | 3.40% |
| Home and mortgage insurance | 1.38% |
| Maintenance and repairs | 1.66% |
| Other accommodation expenses | 4.26% |
Most crucially you may notice that what isn’t captured in the index is the single biggest line item on the budget of most households: the mortgage. Only the mortgage interest is covered, and at today’s ultra-low rates, that means most of today’s large mortgage payments are not counted as an expense at all. The rationale for this is simple: mortgage principal repayments are savings, not an expense. Thus in the eyes of statscan, counting the whole mortgage payment as an expense would make about as much sense as counting your RRSP contributions.
Added to this is that just like for tenants, for owners the CPI measures costs for the entire population. When interest rates drop, it affects many owners immediately (those on variable rates), and others pretty quickly (through refinancing or renewals). But only about 4% of homes change hands every year in Victoria, which means it takes many years until house price increases filter through and start being fully felt in the CPI. As a measure of house prices, the CPI lags by years or decades.
What’s the issue with CPI and tracking housing inflation?
Given that, it shouldn’t be a surprise to anyone that house prices and the CPI are disconnected. However there’s two issues I have with the way the CPI looks at house prices. The first is that the replacement costs are seemingly based on New House Price Index, a fatally flawed index of new house prices which implies that new house prices haven’t really budged in decades. I believe the complete disconnect between actual prices and this index is because of aggressive quality adjustment, but I have contacted statscan for details on how the index works.
The other is that I believe it isn’t quite accurate to simply write off mortgage principal as savings and ignore it. Choosing to put $1000 per month into your RRSP is quite different than being forced to put the same amount into a mortgage. In addition the savings in the form of home equity are relatively illiquid. As recently as 2010 you could extract 95% of the equity out of your home through refinancing, but that ratio has since been reduced to 80%. In other words the first $200,000 in home equity on a million dollar home is functionally inaccessible. If you can’t use your savings, are they savings?
Taking a step back, usually when you’re saving, the savings are a means to an end. You are saving in order to buy something later. Today a buyer would need to “save” a million dollars (+interest) for the same house they would have only had to save $250,000 for 20 years ago. But in the end the result of the savings (one house) is no different. We’re in an odd situation where what people are spending on interest is historically low, while those who can still afford to buy in find themselves forced into extremely high rates of saving. Is there such a thing as too much saving?
For Statscan’s part, they acknowledge that the CPI does not reflect house price appreciation, but say that it’s not a problem because it was never the purpose of the CPI to begin with. That’s fair, but given the sensitivity of house prices to interest rates, and the key role of the CPI in the Bank of Canada’s rate decisions, one wonders what would happen if it did.
Also weekly numbers courtesy of the VREB.
| August 2021 |
Aug
2020
|
||||
|---|---|---|---|---|---|
| Wk 1 | Wk 2 | Wk 3 | Wk 4 | ||
| Sales | 164 | 979 | |||
| New Listings | 243 | 1333 | |||
| Active Listings | 1311 | 2584 | |||
| Sales to New Listings | 67% | 73% | |||
| Sales YoY Change | -21% | ||||
| Months of Inventory | 2.6 | ||||
No great change in the market since the end of July. New listings continue to be missing in action while demand remains quite strong for what little there is out there. I’ve heard a few anecdotes now that there are a lot of listings queued up for September, and they are desperately needed with inventory now 52% above the levels we had this week last year. Sales are 21% slower than last August, but about 17% ahead of the pace in 2019. Everyone’s on vacation including the realtors, so don’t expect anything exciting to happen in the market before September. 
new post: https://househuntvictoria.ca/2021/08/16/will-climate-change-lead-to-an-island-population-explosion/
OK, let’s update the teranet data to reflect the recent increases seen in 2021.
If you assume a 15% increase in 2021 (vreb shows SFh up 19% this year and condos up 5%),
then this would worsen the teranet affordability chart from 56 to 64.
This 64 is about average affordability on the teranet chart.
Well below unaffordability peaks (2007 – 85, 2009 – 69, 2018 – 72)
For example, prices would need to rise an additional 33% from here (64->85) to get to the unaffordability peak measured by teranet in 2007. (And prices are currently up 80% for the “poor fool” who bought at the worst unaffordability year (2007) in the teranet chart).
Victoria house prices: https://www.vreb.org/media/attachments/view/doc/2_2020_historic_average_selling_price_graphs/pdf/2_2020_historic_average_selling_price_graphs.pdf
Teranet affordability data: Page 11 https://housepriceindex.ca/wp-content/uploads/2021/02/housing-affordability-q4.pdf
And of course the affordability picture is much better than shown, because the affordability calculation includes the entire mortgage payment (interest and equity) , when 79% of mortgage payments are equity (forced savings, over a 25 year mortgage at 2% interest). That means someone, (on average over 25 years/2% mortgage), with a $2000 mortgage is paying per month $420 down the drain on interest, and saving $1580 with equity into the house. Lots of people realize that, and that’s why they’re buying.
Also Teranet was wickedly laggy just like the MLS HPI until recently. Even in March they were still saying +10% when we were up between 20-30%
Maybe – at this point it looks like the chart is only up to the end of 2020. If we assume Teranet prices are 2 to 3 months delayed due to the way they measure we really only have pricing up to about October – though the interest rate drop would be fully priced in as that happened q1 2020. Since Covid, the majority of our price gains have happened after October so I wouldn’t put too much stock in to how affordability is today based on that chart – it paints a nicer picture since it captures the reduced mortgage payments without the majority of the increase in prices. Next years will paint a more accurate picture assuming prices don’t change drastically over the next few months.
Also not surprisingly it shows on the first page ‘saving for a down payment has never been worse’.
Those trying to reconcile Leo’s and Introvert’s charts should note that Calgary and Edmonton have a much higher birth rate than Victoria as they have a higher proportion of young families. They also get far more immigrants per capita.
Victoria is almost alone among CMAs in having fewer births than net interprovincial migrants. The other one is Kelowna.
https://www150.statcan.gc.ca/t1/tbl1/en/tv.action?pid=1710013601
You’re taking one component of population growth and declaring that it’s a region in decline.
Reality is population has been growing in Calgary and Edmonton much more quickly than Victoria (partially because their housing supply is more elastic) and there has been no indication any of that changed after the oil downturn. Population growth still rapid.
Look at the Y axis of your chart. The peak is about 10,000 and the trough is about -5000. For a population of over 4 million, that is about 0%. It just isn’t a significant factor.
Not sure how to reconcile your graph with this one. Maybe Albertans are having a lot of babies?
https://www.atb.com/company/insights/the-owl/interprovincial-migration-first-quarter-2021/
Someone forgot to tell them they should be moving away.
I wonder. I think you can stay flat for a long time if the economic base is damaged and doesn’t recover. Case in point being the Maritimes, which has only recently experienced a lot of appreciation (excepting Halifax) due to its super cheap prices for RE (due to decades of low to no appreciation) and the rise of remote work. Climate change reports and recommendations are not boding well for Alberta fossil fuel extraction. Maybe Alberta can pivot to lithium mining or something – I don’t know.
At some point, yes, probably. But when that point is may be a ways off. I think it’s been four consecutive quarters of interprovincial net population loss for Alberta. Oil and gas jobs have been in decline since 2014. The demand-crash caused by COVID forced several majors to merge and “find efficiencies” (a.k.a. lay off excess workers). Meanwhile, automation in the oil sands continues. The UCP government isn’t diversifying the economy, choosing instead to bet big (and lose) on things like Keystone XL. And, just for fun, they started a war with the province’s doctors, and are currently offering Alberta’s overworked and exhausted nurses a 3% wage rollback!
There’s an ongoing narrative here about the crisis level unaffordability of housing, with affordability charts to back it up.
I’ve made previous posts suggesting that Victoria housing affordability isn’t so bad from a historical perspective. Here’s some data that backs that up…
Ternanet publishes housing affordability index, using the typical metrics (mortgage payment as a % of income).
They tell a different story than some other affordability charts. For example, their latest release (February 2021) shows affordability level at 56, which is a huge improvement over 72 in 2018. Moreover, 56 is about the best (most affordable) Victoria housing affordability they’ve measured since 2003. They also chart affordability of buying vs renting, and that is near all time best affordability for buying 2 bdr condo instead of renting. .
You can see all this on page 11, in a chart. and the data behind it on page 12. Their sources are stats Canada and national bank of Canada (teranet)
https://housepriceindex.ca/wp-content/uploads/2021/02/housing-affordability-q4.pdf
Calgary is probably in for decent performance. You can stay flat for 15 years but not 25
In my view it’s kind of nuts what $825K can (or should I say can’t) buy in Victoria or much of BC. And I don’t think $825 for a house in Calgary is much of a bargain considering its economic prospects, and the expanses of empty land surrounding it.
But when just about the whole country has gone bonkers, sometimes who is nuts and who isn’t gets obscured.
Here’s a prediction for the federal election just called: no party is going to advocate lower housing prices.
We’re currently in Calgary. Spent some time with a good old friend today. He and his partner recently bought an extensively and impressively updated house in the NW neighbourhood of Edgemont.
Yeah, so it’s kind of nuts what $825K can buy in this town. Plop the same house most anywhere in Victoria and we’re probably talking >$2.5M.
I certainly don’t want to move back to Calgary (did I mention it’s been smoky here nearly every day since Canada Day?) but goodness gracious what a bargain RE is here, and god damn what a sweet house my friend is living in.
What’s the incentive for a money laundering transaction to go below market?
You might be thinking of private sales, but that’s not the same thing as non-market.
NaN-Bingo!
I bet those “non-market” transactions have more to do with money laundering than family.
Here’s a PDF of that Globe and Mail article, so everyone can read it:
https://docdro.id/5uAPeDk
Also may be a change to joint tenancy upon a single owner getting married.
Do they know what portion of these were 100% transfers, vs a partial transfer?
I know of people were a family member will go in at 1% to help secure a mortgage and then they transfer the 1% at first renewal. I assume some of these are also transfers between spouses that are going through a divorce or transfering to one spouse for tax reasons.
You never know what’s going to happen after you die.
Better to get it all over and done with before hand, so no one can misinterpret your wishes.
Governments in the future might introduce capital gains tax on sale of principal residence or a wealth tax a gift tax or some other taxes on transferring your house to your child. So if you’re gonna do it maybe sooner is better.
There’s plenty of people here who could think up special new taxes to apply to parents transferring a house to a child
I’m definitely not a tax expert, so can someone explain the benefits of transferring a property to a child instead of waiting for it to get tied up in an estate inheritance. Possibly a ton of probate fees can be avoided. My mother transferred the family home and cottage into my name years before she passed. Sure saved a lot of aggravation after she passed. All it cost was land transfer taxes. Years of capital expenditures negated capital gains on the properties. When this was done both properties were worth around $200,000.
New data show high share of B.C. home sales are between family members
https://www.theglobeandmail.com/business/article-new-data-show-high-share-of-bc-home-sales-are-between-family-members/?ref=premium
Nearly 40 per cent of detached house sales in Metro Vancouver in 2018 were non-market transactions, the majority of which were among relatives, according to a new government report that shows for the first time how big a role families play in generating housing wealth.
Leo, I find NBC uses a pretty unintuitive layout in those reports. They do indeed use median income to determine months to save a downpayment. They also don’t factor the downpayment into the income required to purchase the representative home for some reason.
Better Dwelling LOVES this of course, they just blatantly ignore the methodology and misreport the numbers.
If a house sells for $1m and interest rates are 0%, I would consider that houses are “free” (ie ownership cost is zero excluding taxes and maintenance), because the mortgage payment would just be like depositing money into a savings account at 0% interest, which you would get back when the house is sold, assuming no appreciation.
So the closer that interest rates are falling towards 0% should be reflected on an affordability chart to indicate that houses are becoming cheaper.
If you redid your affordability chart by showing only the mortgage interest cost and removing the forced savings component, it would likely show that affordability hasn’t worsened that much over the years after all because interest rates have fallen.
I expect that some people here wouldn’t like the idea of only including mortgage interest in affordability calculations. But they may be the same people that have delayed buying a house because they think prices are going to fall and no one can afford them. It could be that the people that Are buying them are people that realize that 79% of all mortgage payments are for savings if interest rates are 2%.
Someone buying a house is justified in forgetting about other savings methods like RSP because they are already saving lots of money each year via mortgage equity payments. Whereas a renter should be concerned with investing in RSP and other savings to plan for retirement.
So this affects affordability where the renter has extra costs of saving for retirement and the homeowner doesn’t. The people that realize that are buying homes whereas the people that don’t are bewildered as to who can afford homes.
The better question for someone borrowing $800k for a home is if they are able to afford the $1,600 interest payment on the 2% mortgage.
Maybe they are calculating the 10% off net pay instead of gross pay.
Sales for the 2 to 4 mil houses seem to have really slowed down the last few weeks.
Mind you, August is not traditionally a high sales month.
Leo just looking quickly maybe they aren’t using the 176K as savings calculation – maybe its median income they are using. Seems backwards as they are referencing you needing to earn that to qualify but i think it would make more sense to use median income if you are talking about months of savings and affordability.
Anyone understand this math? 338 months of saving 10% of a $176k income is $495,000. Way above the minimum down payment on a $1M house.
Fair enough the liquidity differences may be impossible to capture.
Substantial difference between forced mortgage savings and voluntary investment into most anything else that is a lot more granular (I can choose to buy $1 or $10 or $10,000 chunks).
It’s the opposite with vehicles by the way. StatsCan takes the entire entire payment as a cost, not just the interest portion. In reality though, half of the payment is principal, and in 5 years when I sell it I’ll get about half that principal back. An innacuracy, this time in the other direction. My point about their approach to owned housing is that they are missing the very real costs of having that money tied up, and not quantifying the effect of having a very high bar to even get in. Perhaps an approach based on opportunity cost could work.
That’s some overpriced land. This particular house was designated heritage so they would be buying the house too.
With only 400 sfhs on the market, people aren’t buying homes, they’re buying land. Apparently, the structure is no longer relevant.
The market seems to be going wild. Places selling unconditional before I can even get into view. One place had water damage from the roof and basement on the disclosure and still went unconditional. This was a house they couldn’t give away two years ago when it was on the market. I really hope people aren’t getting in over their heads with these insane bids.
I agree ted, but your going to have to wait for the old grey hairs to croak before any townhomes or duplexes get approved in those areas
You can borrow against term deposits.
These kinds of units should be available all over Fairfield and Oak Bay…
https://www.realtor.ca/real-estate/23505466/1-1827-fairfield-rd-victoria-fairfield-east
I think you are getting hung up on terminology ie. “savings” that is imprecise when we actually have the terminology to further describe assets clearly. House equity is illiquid unless you can borrow against it and it is also subject to transaction costs and higher volatility but your savings are invested savings plus the ROI. Term deposits are not volatile, low risk, but illiquid until the term is up and are a form of invested saving and ROI. Cash and savings accounts are liquid but unvested so no or minimal ROI. The fact that you have an illiquid investment of savings that you can’t borrow against doesn’t mean it is not part of the balance sheet.
If I put 20% down on a house, and it doesn’t appreciate, I can withdraw all of my equity from my mortgage payments (since I can borrow up to 80% of house value). What’s better about putting the money into a 5 year GIC? If I withdraw from a GIC, I lose the investment. If I withdraw from my house, I keep the house. That seems better…no?
There is no investment that is “always available”, and allows you (in the absence of appreciation) to withdraw all invested funds and let you retain the investment. Houses are no different, so I don’t understand the distinction you are trying to make.
Yes but this is a separate factor. The fact remains that there’s a difference between savings that are forced vs voluntary, and liquidity that is always available vs one that depends on price appreciation. Statscan treats those as the same thing. I don’t have an answer for how to change the system, there are no easy answers here, just pointing out the difference.
It does in a way. But it does it for all Canadians. When two thirds of Canadians own, the huge increase in house prices last year had no effect on their personal expenditures. In fact the drop in interest rates last year means their costs immediately dropped substantially.
Also as I mentioned in the article much of the monthly cost for owners is actually savings even if it’s different than normal savings.
That was an extremely helpful explanation of where the inflation index comes from. I’ve never seen it explained so clearly.
Can you explain why tracking the surge of house price appreciation is not part of the CPI job in the first place. Shelter is the single biggest cost for Canadians and if there is runway inflation in that sector why should the CPI not track that.
If that is not part of their job to track shelter inflation than maybe the department simply needs to be fired altogether since it seems to me that they are just making up pretend numbers.
I am starting to wonder if Canadians have become so used to being lied to by every level of government that we simply quietly accept it.
In what fantasy world have home repairs only increased 1.6%? The price of materials alone has gone up a lot more than that. Labour has also really gone up,. Look at the price of a gallon of paint or a piece of plywood or anything else for that matter. The price of building materials (and just about everything else) has surged across the whole country.
Patrick: You are correct but only based upon your assumption that house prices endless continue to appreciate. In fairness your assumption is likely to be true at least in the short run.
Great article. Thanks.
Due to house appreciation, in most cases the homeowner can use (borrow)100% or more of their savings, while retaining the investment in the home . Unlike the rsp investor that can’t use (borrow) anything without selling and losing the investment.
In your article, you’re using the terms “savings” and “equity” interchangeably, but they’re different. Equity in a house consists of price appreciation + savings created by down payment and paying off the mortgage.
Take an example of someone who buys an $800k home. He has paid $160k down and let’s say he has also paid down $50k on his $640k mortgage. His “savings” (analogous to the rsp contribution) is now $160k+$50k=$210k. He still owes $590k.
Now you’re suggesting he can’t access that $210k savings, since the most he can borrow is 80%. But that’s 80% of the current house value, not the original value. If the house is currently worth $1m, he can borrow $800k, which is $800k-$590k=$210k available to borrow. That means he can “use 100% of his savings”, so the answer to your question is YES.
If the house is worth $1.5m, not only can he extract and use 100% of his savings, but he can extract and use ($1.5m*80%)-$590k=$610k, which represents all of his savings ($210k) and an additional $400k of extractable “paper” appreciation. All of this extracted by using the house like a tax-free perpetual ATM machine.
Note that the rsp investor can’t extract any savings without selling the investment. It is the hapless rsp investor you should be referring to when you ask “If you can’t use your savings, are they savings?”.