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Understanding Pent-Up Demand In Real Estate, And How Central Banks Broke Markets

“It’s pent-up demand, bro – the market’s recovered” is one of the most common things I hear these days. Unfortunately, most people parroting the words don’t actually understand what they’re saying. Pent-up demand means a temporary surge of buying activity, that falls when demand catches up. Temporary being the key word. Under normal circumstances, this occurs as the market begins a rocky recovery. However, central banks deployed unconventional monetary policy at the beginning of this downturn. This has resulted in pent-up demand surfacing in the middle of a pandemic. How this will  resolve is even a mystery to central banks.

Pent-Up Demand

Pent-up demand is a brief period of consumption where purchasing is unusually high. This follows a period of unusually low, restrained activity. This can be due to policy influence (a foreign buyer tax, vacancy, etc.), but it’s most closely associated with economic downturns. Basically, people delay purchases until the economy has exited its recessionary phase. Those delayed buyers typically meet with the regular cohort of buyers, and activity appears unusually high. It seems a little odd to casual observers, but it dies down once the delayed buyers are caught up.

That was a little dry and may be hard to visualize, so let’s run through an example. Let’s say a new mortgage stress test is implemented, reducing typical demand by ~30% in the first month, 20% in the second month, and it normalizes at 90% of typical demand the third month. The reduced demand in the first month isn’t permanent – most of those buyers are only delayed. If half of month one is delayed into month 3, this pent-up demand would create 105% of the typical volume of sales. It may seem like there was no impact, but after the pent-up demand catches up – you’re left with reduced volumes. 

Why Does This Occur? 

Why this drop in activity occurs is important to understanding the current market surge. Conventional wisdom suggests people don’t borrow in a downturn because they’re broke. Possibly scared of what’s happening around them. The belief is a consumer driven decision has been made. However, research has shown for decades this isn’t the case. Households aren’t cooling off because they’re worried they’ll be overextended. Households don’t borrow because lenders shut off the taps.

Humans aren’t great at self-regulating their own risks, but free markets are. When risk is high, lenders demand quality borrowers, and charge higher interest rates. This reduces the number of borrowers, but also compensates them for additional risk. By reducing liquidity, only people with solid financials should be able to drive the market. This isn’t just because the system favors wealthy people – although it does. It’s because people without a cushion or secure employment shouldn’t take out high ratio loans in downturns. Otherwise you end up with non-market activity, like special treatment of mortgage deferrals.

How Central Banks Broke The Market, Without Knowing What’s Next

Now it might make a little more sense why the recession isn’t over, but pent-up demand is appearing. It’s not because lenders aren’t weary of risk. It’s because central banks flooded the market with cheap money, regardless of risk. At the beginning of the pandemic, mortgage rates began to climb and organizations like the CMHC, Canada’s state-owned mortgage insurer, increased qualifying criteria. This is how markets are supposed to work. 

However, just a few weeks after the recession kicked off, both Canada and the US flooded the market with cheap mortgage credit. The US Federal Reserve began buying mortgage bonds at 8x the rate seen during the previous buying sprees. The Bank of Canada began buying the Canadian equivalent at a pace of nearly $1 for $4 of mortgage credit expansion. Remember, despite conventional wisdom, people borrow when they can, not when it’s ideal. This cheap attempt at propping up GDP resulted in pent-up demand surfacing in the middle of a recession, instead of at the end of it.

Pent-up demand is a temporary surge of consumer spending, that typically appears at the end of a recession. It usually fades after demand has caught up, and the market’s full risks have become known. This time it surfaced soon after the start of a recession, as central banks enticed borrowers – regardless of their personal risk. As demand catches up, and future demand is pulled forward, it’s unclear what steps central banks take next. Especially considering they’ve already used tens of billions in firepower, typically reserved for a recovery – not a downturn. 

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15 Comments

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  • Mortgage Guy 3 months ago

    Correct. There was an agent on the news discussing this exact issue.

    The market is spring pushed forward, but the rise in listings is approaching the winter. Unless people brave the winters to absorb demand of late fall inventory, it will sit until the spring.

  • Ethan Wu 3 months ago

    Funny. Hilliard’s blog post today was about the Bank of Canada pretty much admitting they have no clue what to do.

    “Bank of Canada runs out of ideas”

    https://web.richardsongmp.com/MacBeth.MacLeod/blog/1737481-Bank-of-Canada-runs-out-of-ideas

  • LT 3 months ago

    Great article. I always have fun with this one in class, and discussing how sales volumes surged after the bubble was identified in SoCal, and people thought the market was going to go up forever because it bounced back.

    When you hear a lot of people say it’s going up forever, it’s time to step back. You may not know how far the top is, but it’s getting to the point where you’ll find out.

  • Rick Hyne 3 months ago

    The system is setting people up to fail.

    The migration from condos to places with a front door and a piece of grass caused by the fear of being locked in a box for six months; coupled with low interest rates has meant people are willing to throw caution to the wind.

    What will they teach in economic classes going forward? I doubt we’re following any rules here.

    There is no pent up demand. There is fear!

    The entire landscape has witnessed one of the biggest earthquakes in modern history.

    Those well positioned have done great, others not so much.

    Let us not forget about the almost one trillion in government funds flowing throughout the economy.

    I heard from someone the other day whose neighbour is a manager at one of those cheque cashing places claiming of the number of individuals cashing their and their alter-ego cheques.

    Jane Doe (married), Jane Smith (before marriage), Jim Doe (13 year old son of Jane). $6,000 per month. Try and collect taxes from these type of people. That’s the economy.

    The person I spoke with also works for Home Depot.

    Record sales. Lumber prices have almost tripled in price.

    I told her record sales today, no sales tomorrow.

    For those who thought the lock down was bad, you better be prepared for what is coming now.

    No government has the financial wherewithal to roll out type of stimulus needed between now and next spring. It is going to be all hands on deck as multiple outbreaks of COVID-19 and other respiratory diseases slam the population thanks to naysayers and non-believers who think this is all a hoax.

    The orgy is over. Play time is coming to an end.

    Good luck to all.

    • Kolf 3 months ago

      Rick I agree with you, I work in one of the big 5 under risk management…. The numbers Im seeing are alarming, I dont know what kind of irresponsible government we have, but its insane to fuel a housing bubble if you plan a recovery in 1-2years.

      They should have used this crisis atleast to solve the housing cost issue and be one the road the recovery by 2022. Now with this crazy bubble there will be no recovery because housing costs will drain all the money out of the economy.

  • SH 3 months ago

    Based on the explosion of rental listings in Toronto, it is now the season of pent-up SUPPLY.

    • alvi 3 months ago

      Great news affordability crisis over

      • Groot 3 months ago

        Look closely at the supply of condo’s and you will notice that a lot are bachelor units and small 1 bed units under 500 square feet that were designed to be more like hotel rooms. A huge chunk of former AirBnB units are hitting the market and most people do not want these. The government should just buy these up for dirt cheap and uses them as affordable housing to at least deal with the growing homelessness problem in the city.

        • The Truth Will Set You Free 2 months ago

          The government is way ahead of you. The government is handing money to condo development projects already underway to ensure they get finished. In exchange these developers have to include low income housing condo units within the project. An example of this is at the KIP condo development on Dundas. So far the government pitched in around 6 million. Now people who put down deposits to buy into a prestigious condo development like this one (sometimes putting down depositing years back) will lose value on investment.

  • JOE P 3 months ago

    EVERYTHING the government is doing, take today’s new UBI announcement for example, is to continue the housing market orgy in Canada because years of bad policy made it our main Economy.
    This endless COUNTERFEITING of money by central banks essentially flows up the real estate chain to property owners, saving their asses from calamity. IF the cost of housing was in the CPI, and central banks actually followed their mandate, interest would be very high.

    REMEMBER, Every single policy put forth is to prevent a US style housing market crash and it’s disgusting because it’s creating two socio classes, those with real estate and those without. The longer you wait the more your going to pay, because the GOVERMENT has allowed this. Housing was already over extended before the pandemic, because they make more taxes on forever inflating house prices.

    So if you decided to wait for free and open market forces to prevail, the government is there to change the rules just in time. I do not agree with it.

  • John C 3 months ago

    When do my stock market investments get protected to the downside like Canadian real estate did in the last two market crashes? Actually, who do I contact if my downpayment was lost during the market crash? Do they realize the weath gap that’s being created when they don’t allow housing to go down with the rest of the economy? This is exactly why the housing bubble was created and has left Canadians who believe in free markets Priced out over the years.

    All monetary stimulus programs are intended for the housing market to stay afloat. Think about it, eventually the printed money makes its way up, further driving wealth divide.

    They will continue to change all the rules as they see fit, I don’t agree with it and people who don’t own RE need to start contacting those in charge.

    • Rick Hyne 3 months ago

      You have a point.

      We have no risk management any more. Everyone wants to be protected from their decisions.

      When we compare the current pandemic to other natural disasters such as floods, fires, earthquakes I have never seen a government swoop in and hold the hands of Canadians like we have done now. The only difference was that this was government made problem by closing everything down, and not a natural occurrence as would be the case with fires, floods etc.

      What we have today, across the globe is an ability of the governments in power to manipulate their jurisdictions.

      As far as stocks, that looks more and more like a casino.

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