Andrew Pyle
March 24, 2023
Housing sector concerns in Canada are complicated
On our conference call this past Wednesday (playback details can be found at the end of the newsletter), one of the participant questions had to do with risks to real estate. Considering the dilemma in the US banking sector and the fact that interest rates continue to rise, the question was intuitive. Housing has already undergone a retracement over the last year in the week of higher borrowing costs – a correction which was exaggerated by overvalued homes at the peak of cycle. Talk of recession later this year makes for an even more dreary outlook for housing in North America.
The last year has certainly seen an erosion in this sector. As the above chart shows, US homebuilder sentiment cratered in 2022 to roughly the same level seen at the start of the pandemic. This low came just two years after the index reached a record high of 90. Since December, confidence among US homebuilders has improved, thanks in part to a moderate decline in mortgage rates since October. According to the Canadian Home Builders’ Association, the CHBA Housing Market Index (HMI) fell for the third straight quarter to 26.2 in Q4 and the latest report indicated that 77% of CHBA members said there was less buyer traffic due to higher interest rates.
Interest rates have definitely dampened housing demand for new and existing homes, but builders continue to face numerous challenges, from higher costs for permits and to still elevated prices for materials. True, we have seen a sharp decline in lumber prices from the recent peak in March of last year, but they still aren’t any lower than just before the pandemic. Copper futures, however, are up almost 50% since the beginning of 2020 and have retraced more than 50% of their losses from February of last year to last summer. On top of that, builders are still dealing with labour shortages and higher wages. Official numbers out of Statistics Canada point to less than a 4% increase in the union construction wage index from just before the pandemic to last year, though many builders that we know would disagree with that figure.
With these headwinds, one could definitely imagine that the housing sector is on its knees. Construction activity has cooled from the boom period at the start of 2021, but this is hardly a collapse. As the chart shows, total Canadian housing starts reached 321,000 units on an annualized basis two years ago. In January, they had fallen to 216,000 but this was close to the 10-year moving average and better than the long-term average of 190,000 (data goes back to 1977). In February, starts bounced back to 244,000 and that isn’t far off the cyclical peak of 248,000 in 2017.
Given the information that we heard this week, it’s good news that construction activity hasn’t died off, and it looks like we are about to see a revival in sales and prices as well. This information was contained in a report by Statistics Canada that showed Canada’s population grew by 2.7% over the course of 2022, or 1,050,110 individuals, to over 39.5 million. More than 95% of this growth came from international migration. According to the report, if Canada’s population were to continue to grow at this pace, there would be close to 80 million people in this country in 26 years.
That would be a huge feat, though not impossible. If geopolitical tensions continue around the world, from Eastern Europe to Asia, then Canada could continue to see a strong influx of new Canadians. Already, Canada’s relatively more open approach to immigration has allowed it to more than double the population growth rate of the US. Theortetically, this should help insulate Canada from the risks stemming from an aging population and could even raise the country’s trend growth rate since potential GDP growth is the rate of employment growth plus productivity growth.
This growth, however, also comes at a cost. First, strong population growth will lead to higher demand for housing. While good for home prices and sales, we are already dealing with a supply shortage of both single and multiple-unit homes. Urban centres are already become denser and transportation infrastructure is woefully inadequate already.
This week, Ontario tabled its latest budget and referenced the population boom from last year and how it could lead to a 21% increase existing home sales in 2024. The province also sees prices rising 2% in 2024, which might actually turn out to be conservative, especially if the demand-supply gap grows wider. This will cause a further deterioration in home affordability and, if the inflationary spin-off from increased home prices (and rent), adds to the already persistent inflationary pressures on the services side, then rate cuts could be a long ways off. The Bank of Canada may also be forced to resume tightening. With a household debt load that is already excessively high, this could create even more stress for overly-leveraged homeowners.
And that is why Canada’s housing market and outlook is complicated. Increased immigration might provice the elixir to generate a quick recovery from the interest rate induced weakness in sales and prices from last year, but the net result could also create a vicious feedback loop. This also ignores the social costs, such as the availability of medical services for a fast growing population as well as education. Next week’s federal budget is going to be closely watched for new tax initiatives, and there are supposedly going to be measures aimed at healthcare and the environment. It would seem that housing needs to be at the top of the list too.
On behalf of the Pyle Group, have a wonderful weekend.
Andrew Pyle
Conference Call Playback Details
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Local dial-in number: 905-694-9451
Passcode: 8133173#
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