E-Sight October 8: Home Construction Cools in September, Cracks in condos, Governor Macklem flags risks

We have heard a lot recently about the possibility of a K-shaped recovery – one in which parts of the economy recovery quickly while other sectors continue to struggle. Canada’s residential real estate market has certainly fit the profile of the upper part of the K-recovery with activity in resale markets and new housing construction both growing at a phenomenal pace over the past few months. However, the lift we saw this summer from the residential market may be starting to fade. After climbing above 260,000 units (at annual rates) in August, housing starts slipped to 209,000 units in September. While this is still a healthy level of new home building, it is another sign that post-reopening bump in growth is starting to slow.

During the height of the pandemic’s first wave in the spring, new home construction was restricted in some areas of the country. When activity could resume, we saw a surge in housing starts. After averaging over 250,000 units over July and August, new home construction cooled to a pace of 208,980 in September.

Some decline in housing starts was anticipated given that the outsized gains during the summer reflected activity that would have otherwise taken place during the spring. Indeed, despite the deceleration in September and the sharp decline earlier this year, housing starts for the year remain on track to match, or slightly exceed, their 2019 performance.

Lower home building activity was observed in most parts of the country last month with Alberta and Nova Scotia the only exceptions. The decline in housing starts was largest in Ontario, driven down by a steep drop in multiple units, which are often volatile and had experienced a sharp increase in August.

Housing activity is being supported by low interest rates and the fact that job losses have disproportionately affected lower income Canadians who are less likely to purchase homes.

We expect that interest rates will remain low for years, continuing to support residential investment. However, the recent rise in resale condo listings is a potential risk that we are watching as signs of oversupply in that market would dampen the incentive to construct new multiple dwelling units which make up the bulk of Canadian housing starts.

The Toronto Regional Real Estate Board reported that listings of condos in downtown Toronto hit a record at the end of September and were 215% higher than a year earlier – dramatically higher than the 5.3% rise in total housing listings in Toronto. The cost of renting in the GTA is down roughly 11% year-over-year, suggesting that the additional listings might be coming from rental units or investment properties that are not providing the expected returns. This was a risk we flagged in past months. We argued that the recent strength in real estate is likely to cool as more of the economic scars of the recession are felt and as a second wave and increased health risks are felt. The most vulnerable segments of real estate is commercial properties impact by the shift to remote work and business failures in hard hit industries and residential condo apartments that will be less attractive during the restrictions of the pandemic and the shift to remote work as well as the reduction in rental income, particularly from travelers. 

Meanwhile, Bank of Canada Governor Macklem spoke at the Global Risk Institute today, and his comments fit the venue as he provided a discussion of risks in the short, medium and long-term. He suggested that the most acute financial risks from the current downturn have been managed, which is a fair assessment. Yes, there have been, and will be, credit losses, but massive government support programs have limited the fallout. However, the Governor also speculated that the pandemic will likely worsen pre-existing vulnerabilities – such as frothy housing markets and elevated household debt. Although the low interest rate environment could aggravate these risks, he was clear that the first line of defense is changes in government macroprudential policy. This is the same position as former Governor Poloz, and it is why there were many changes to mortgage regulations and other policies over the past decade to temper real estate and debt growth. Governor Macklem also flagged climate change risk, and noted that the Bank is trying to better understand the implications of climate change on the economy. This is a trend of central banks and bank regulators around the world, which is a likely precursor of more climate stress testing for financial institutions