Condos are the biggest challenge facing Canada's economy right now.

This is the biggest challenge facing Canada’s economy right now.

It is one of the biggest challenges we've ever faced.

There are BILLIONS of dollars in unrealized losses in the condo pipeline that will be absorbed by retail investors.

Many buyers don't want to take possession of the units they committed to purchasing. Just as many can't afford to.

The 2nd-order effects of this will last a decade, especially in the construction industry if we can't get things back on track.

I've been sounding the alarm on this for several years now, and I'm sure you're tired of listening to my permabear broken record bemoan this problem.

Fortunately for you, CIBC and Urbanation Inc. just put out a great report on it.

CIBC Capital Markets recent report shows construction activity dropping fast:

If this trend continues much longer (which it will based on today's sales) we will have real problems in Canada's employment markets. Maybe the eventual fix is in 2026 when the government actually realizes we have this problem, and pencil a massive infrastructure spending bill to keep those trades employed when the highrise construction pipeline shrinks by 50% to reflect present day preconstruction sales.

Unfortunately, that doesn't fix today's inventory problem, or the liquidity problem facing unit holders.

So, Canada's banks are doing the best they can to figure that one out on their own:

Canada's banking system is figuring it out

Banks are already scrambling and taking significant risk and making serious compromises to accommodate and keep the system moving. CIBC's report acknowledges below that almost 75% of investor loans are held by Canada's Big 5 Banks. In many cases, based on the valuations I've seen (shown above) on new units closing today compared to comparable 1-3 year old resale in the same area, these valuations are well above current resale, which is trending down at an alarming rate.

If banks are lending at 80% loan-to-purchase-price on these closings, they're likely well above 80% loan-to-value when value is measured at fair market value (FMV) set by today's resale market. This is a likely violation of a few important rules in Canadian Banking. Even if it's not a direct violation (given extenuating circumstances) it is a very risky sandbox to play in regarding the Bank Act, Basel III, and G-SIB requirements. To date, we haven't seen an acknowledgement on this practice from OSFI.

Builder bailout could be necessary

The government would be very wise to get working on a CMHC insurance or similar program to get unsold inventory product into the rental market, rather than sitting empty and bleeding out builders and developers, and causing a liquidity crisis for new owners:

• If builders sell the units at today's resale values, their project will likely not make enough profit to liquidate the construction loan.
• If builders sell the units at today's resale values, they devalue the building and further compromise the retail investors who took possession.

So instead, the builders put inventory loans on the units, typically at a higher capital cost than traditional residential financing. This would be fine if the units could sell in today's market, but they can't, because they're competing with record resale inventory in a market that has almost gone no-bid.

This is tens of thousands of units that could be added to the rental supply that would otherwise sit in inventory. It would be a big political win if you get past the part about bailing out builders (I think that's a win too, but I'm not the one trying to convince voters of that.)

It is easy to say speculators or developers shouldn't get a bailout. It could be necessary to save Canada’s economy from serious pain in the coming years.

I don't want to be too alarmist here. Big developers will be fine. The ones who scaled too quickly will not be fine. We have already seen this take place.

Great work by CIBC and Urbanation on bringing this to light.