Become a member. Sign up here

Become a member

Already a member?

Forgot your password?

Canadian construction slowdown in the cards; Catch-22s everywhere; Montreal the next shoe to drop

OCTOBER 10, 2012

Construction set to slow....implications on labor market:

I noted in the interview above that by every possible metric, the Canadian economy has become more reliant on the current housing boom to generate economic and labor market growth than the US was at peak, despite the common misconception that the entire US economy was housing and consumer spending.  We're also at or near all-time highs in every housing-related metric.

The residential construction boom in Canada is now growing long in the teeth, and I'll suggest that our capacity to build new units well in excess of what demographics would warrant is nearing an end.  The latest housing starts data showed a mild decline in housing starts in September from year-ago levels, though we're still on track to see 215,000 housing starts in Canada.  As TD noted yesterday,

"Canada still has overbuilding concerns. The level of household formation does not support the level of construction activity that we are seeing each month." 

I agree.  The level of housing construction in Canada in the past decade is well above what the US experienced in the decade leading up to their housing bust once we account for population.  If we indeed see 215,000 housing starts, it would be equivalent to the rate of construction the US experienced in 2004 when their housing bubble was in full swing.  Relative to total population and relative to population change, we've out-built our US peers:

We now have housing starts and units under construction at or near all-time highs in Canada's three largest markets:

Yet this is during a time when sales are falling and MLS inventory is rising.  Montreal is at all-time highs for total listings while sales stall.  Toronto listings are rising while sales crumble, particularly in the condo market.  New Toronto condo sales plummeted 70% y/y.  Meanwhile Vancouver sales and inventory levels are completely out of balance leading to significant price declines already.

And yet more inventory is coming.  Housing completions lag housing starts, obviously.  The numbers suggest that 2013 will see substantially higher completions coming to market at a time when sales are much lower than anticipated.

There's no question that builders will be forced to slow their pace of construction if sales trends don't reverse course in short order.  What this means for the job market is up for debate, but consider this:  In order for construction jobs to realign with their long-term proportion of all Canadian jobs, it would mean a loss of 200,000 positions.  If the "unthinkable" were to happen and Canada were to experience a US-style construction slowdown, it would result in closer to 400,000 jobs lost.

This does not take into account other industries such as building material producers and suppliers, home furnishing producers and distributors, real estate services, and financial intermediaries that rely on real estate transactions.

 

Catch-22s everywhere:

At this point, even if housing starts were to defy logic and continue to remain robust, it remains a catch-22.  We've overbuilt relative to demographic demand and there is a demand gap to contend with.  Whether it will happen soon or whether we will sustain an artificially high level of construction activity and set the stage for an even worse slowdown is now the only question.

On the topic of catch-22s, I should point out that the job market and Canadian housing is embroiled in an interesting dynamic.  In order for house prices to remain robust, we need a strong and growing job market and rates to remain low.  yet those two things are fundamentally incompatible.  Strong job reports raise the specter of higher inflation, causing bond yields to rise.  Note the sharp rise in the 5 year bond yield (which primarily determines 5 yr fixed mortgage rates) after the latest, surprisingly strong jobs report.  It spiked 10 basis points in two days following the report.

A strong and recovering labor market means higher rates by necessity.  And even if the Bank of Canada rate doesn't move one bit, rising bond yields still spell trouble for all new mortgages, fixed and variable.  Fixed rates rise directly with the 5 year bond yield, while variable rate mortgages must have their debt service ratios tested against the Mortgage Qualifying Rate, which reflects the prevailing fixed rate offered by banks before discounts.  And as I've often said, prices can simply not be sustained at these multiples of incomes absent a continued expansion in mortgage credit.  Rising rates OR a weakening labor market will spell the end of that dynamic.  Pick your poison.

 

Montreal the next shoe to drop:

I noted in the interview above that within two quarters, and likely sooner, people would be talking about serious market stress in Montreal and Ottawa.  I've been watching it quietly build for several months.  Today we received the latest data out of Montreal.  It's ugly.  Sales were down to their lowest level in a decade while inventory was at all-time highs for the month.  As a result, the months of inventory (which measures the amount of time it would take to sell current inventory given current sales trends) blew out to 12, a level not seen since the financial crisis.

 

Regards,

Ben

Posted in:

Ben Rabidoux
By Ben Rabidoux

Enjoyed this Post?

Subscribe to our RSS Feed, Follow us on Twitter, Subscribe by email or simply recommend us to friends and colleagues!

27 Comments

  • lilyflor said:
    • 1 year, 6 months

    thank you for the article. it is usually difficult to find any commentary on the condition of the montreal real estate market, but you have confirmed a recent news article I read. I appreciate seeing the actual numbers.

    Reply
    Post a comment
  • deanincaglary said:
    • 1 year, 6 months

    Thank you Ben. As usual, excellent real data vs the RE spin machines.

    I have always said that what worries me most is further slowing in the global economy, leading to a slowdown in our exports. We are a small commodity exporter in the huge global sea. Our biggest customer, the US, is (probably) in a recession with EZ close behind, causing China to consume fewer commodities, along with all the other asian exporters (like S Korea).

    A slowing Canadian economy means fewer jobs, which means it will be tough to service any debt.

    Rising interest rates will become irrelevant in a slowing economy.

    Reply
    Post a comment
  • rp1 said:
    • 1 year, 6 months

    Even if the US has a recession, and I take Mish and Hussman's view that one started already, it should be minor compared to 2008 and on the other side of that we should see US housing starts go up. It's not enough to bail us out, or offset China, but having us all not go down the drain at the same time may have been the (only?) goal of previous policies.

    Reply
    Post a comment
  • Dancinpete said:
    • 1 year, 6 months

    Driving into work early this morning in a suburb of Vancouver, I noted how most of the vehicles on the road were your typical white pickup or panel van driven by contractors, building suppliers, or even tool suppliers. I imagined what the impact would be if even half of these jobs were to disappear. It wasn't a pretty picture.
    On our quiet little cul de sac approx. 40% of the households are directly involved in construction in one form or another. To quote GT, This will not end well.

    Reply
    Post a comment
  • TorontoSkeptic said:
    • 1 year, 6 months

    I hope people can see from this data how absolutely bonkers the Toronto market has become. Unlike the other markets, there has been basically no downswing in total units under construction for 12 years straight, it just grows 7% a year like clockwork.

    I'm sure people reading this don't believe the hype about retiree couples downsizing to 400 sq ft condo towers, so ask yourself why they would keep building so many. I know two people my age (early 30s) who own condos. One spent an unexpected inheritance on it, the other had it purchased for him by rich parents. Everyone else either bought a SFH 5 years ago and hit the jackpot of a lifetime (500k tax-free home appreciation + rental income + HELOCs) or is stubbornly waiting it out. The condo market is just flippers selling to flippers selling to...

    The big unknown for me is what this does to SFH. I live in an area where SFH have gone up 250+% in value over the past 4-5 years. The skeptic in me says "reversion to the mean." On the other hand, all the building insanity has made SFH comparatively much more scarce than they used to be. And all those financial services professional may flog condos for their jobs, but they sure as hell don't want to live in them... as long as they are the ones bidding for houses, I can't see them going down for a looooong time. Would love to see a post addressed to this in the future.

    Keep up the great work!

    Reply
    Post a comment
  • Matthew Gordon said:
    • 1 year, 6 months

    If condo prices fall, who's going to have the down payment to buy the SFH?

    Reply
    Post a comment
  • TorontoSkeptic said:
    • 1 year, 6 months

    I'm not sure those two things are very closely related. 90+% of people I know who own a SFH didn't own a condo first. They basically all had rich parents giving down payments.

    I have no idea who owns or lives in condos - I personally don't know a single one - but I don't think it overlaps with the regular home market nearly as much as people think. I think condo ownership it probably >50% offshore millionaires, investment companies and REITs.

    Reply
    Post a comment
  • Ralph Cramdown said:
    • 1 year, 6 months

    Visit a few condo sales centres and pick up some advertising. See what they're selling, and how they're selling it. Ask yourself who that marketing would appeal to. And that's who's buying. It ain't REITs, and for most projects it would appear not to be the 50+ downsizing crowd either.

    From the way the advertorial goes on TV and in the newspapers/websites, I'd say there's a fair number of young'uns buying who aspire to SFH one day, but can't afford it and want to be close to downtown.

    Reply
    Post a comment
  • Ben Rabidoux said:
    • 1 year, 6 months

    REITs aren't dumb enough to hold condos. The cap rate doesn't make sense for them. You need amateurs to fill that market.

    As for who owns these, the developers and realtors all agree that it ain't offshore money doing the buying, and they've been quite vocal on that front. It's locals, with local money. Plain and simple.

    Reply
    Post a comment
  • Alexcanuck said:
    • 1 year, 6 months

    It's locals, with local money
    It's locals, with local money debt.

    Fixed it for ya!

    Keep it coming, Ben. One of the very few voices with factual data and analysis, and no agenda, ideology or conspiracy theory.

    Reply
    Post a comment
  • James said:
    • 1 year, 6 months

    The correlation between SFH and condo prices is well-established. This is the substitution effect. Loads of examples from US and European markets. Just think about the interaction of people selling a condo to buy a SFH or visa-versa.

    Reply
    Post a comment
  • Wayne Masters said:
    • 1 year, 6 months

    I'm sitting on one of my favorite fallen logs in the local forest 5 km from city hall. It is a beautiful piece of wood and begging to be made into part of a house, not firewood.
    50 ft X 12 X 1 sq ft = 600 board ft. A macro sawmill can cut it up onsite.
    A change in the ALR rules in BC would make SFH more affordable.
    A detailed computer analysis of every sq ft of ALR surrounding cities and towns in BC for best temporary housing usage and upgrading of soil conditions.

    Reply
    Post a comment
  • doris406 said:
    • 1 year, 6 months

    Who's buying condos in Toronto? Yes, 50+ people like me who are downsizing because we're tired of maintaining a SFH. But we, and all our friends, are looking at the older, existing buildings in the downtown core where you can get 1400 sq ft for less money than 800 sq ft new. Who do we know who is buying new? Real estate agents and under 30s, who cant afford or dont know anything better.

    Reply
    Post a comment
  • Appraiser said:
    • 1 year, 6 months
    Reply
    Post a comment
  • Frankasaurus said:
    • 1 year, 6 months

    The people buying condo's are the ones that are relying on the 7% annual returns on their investiment to upsize into a SFH after a few years. Although that strategy has worked for many people, it will also ruin a lot of people who don't understand the nature of the cycle. That's what happens when you never pick up a newspaper and rely on your RE agent to provide non-biased factual advise on something they are selling you.

    Reply
    Post a comment
  • Appraiser said:
    • 1 year, 6 months

    Latest stats from TREB:

    "TORONTO, October 16, 2012 – Greater Toronto Area REALTORS® reported 2,961 sales through the TorontoMLS system during the first 14 days of October 2012. The number of transactions was down by 10.5 per cent compared to the same period in 2011. New listings were up by 5.5 per cent year-over-year to 6,505."

    "The average selling price for sales reported from October 1 through October 14 was $501,146 – up by almost six per cent in comparison to last year."
    _________________________________________________________________________________

    Let's review now. Latest StatsCan report reveals new home prices "up". CREA reports average prices "up." TREB reports average prices "up."

    Any questions?

    Reply
    Post a comment
  • Ralph Cramdown said:
    • 1 year, 6 months

    Just a few.

    Last October, TREB reported 3,477 sales at mid-month. Doesn't that make the sales decline from last year 15%? Similarly, the average price increase appears to be 5.3%, or "almost six" if you're from TREB. But unless you're the proud owner of a 905 SFH, you saw lower gains, or even losses. What's with the droopy prices and sales in the 416?

    Reply
    Post a comment
  • Appraiser said:
    • 1 year, 6 months

    All real estate is local Ralphy. Are SFH in your ultra desireable 'hood declining?

    Didn't think so.

    P.S. Are we splitting hairs on percentages and disputing revised numbers again? Please.

    Reply
    Post a comment
  • Ralph Cramdown said:
    • 1 year, 6 months

    Let's just say that among discerning contractors working near me, stucco is the new stone facade. Doubtless it's just a change in fashion and not a substitute good...

    Reply
    Post a comment
  • Oliver said:
    • 1 year, 6 months

    Hi Appraiser,

    I have 100k cash available for purchasing a house/condo. I've been saving for the last 4 years living in a nice and affordable apartment. Do you suggest I buy now before price go up ? You seems like you know a lot.

    thanks,

    Reply
    Post a comment
  • Appraiser said:
    • 1 year, 6 months

    @ Oliver:

    No. Stay on the sidelines and pray for a crash.

    Even if a "crash" occurs, my bet is that you will continue to wait until prices start climbing again. In the mean time my investment properties will be paid off by my tenants. Principal residence was paid off years ago. Yeah baby - rent free for life.

    Good luck timing the market.

    Reply
    Post a comment
  • Oliver said:
    • 1 year, 6 months

    Thank you for your answer appraiser. I will keep me investment in that case. I was lucky enough to get a 6% average returns over the last years betting on large companies (got just in time after '08)

    Most of my friends who bought condos in new developments in the last 2 years have been telling me the same (giving my money away), but even with all the reports showing gains in value, I can still find a good amount of properties in the same complex as them for the same price they paid. I consider myself lucky of having more selection than they did !

    Reply
    Post a comment
  • Appraiser said:
    • 1 year, 6 months

    @ Oliver: Congratulations. Oh, by the way, were your 6% investment gains tax free?

    P.S. If / when you ever do purchase a home, don't waste time with condo apartments. I've never owned one for investment purposes and will never live in one. Go low-rise all the way. Detached if possible, it's the holy grail of real estate. You heard it here first.

    Reply
    Post a comment
  • Oliver said:
    • 1 year, 6 months

    @ Appraiser : Are your investment properties gains tax free ?

    Reply
    Post a comment
  • Appraiser said:
    • 1 year, 6 months

    I must be mistaken, I thought you were renting and considering buying a principle residence, which of course is completely tax free of capital gains.

    Oh, I see you're talking about investment properties. Different kettle of fish, my friend, with all sorts of tax implications and benefits if you know what you're doing.

    For example, years ago I refinanced an investment property that had increased in value substantially, took that money and paid off the mortgage on my principle residence, then wrote off the interest on the re-financing against my investment property for several years until I sold it.

    Even my acountant thought I was a genius. It's like magic.

    Reply
    Post a comment
  • PetrSyk said:
    • 1 year, 6 months

    You guys are sounding weird. Best way to make money is the following: Get a good education (preferably a science background), and find a good paying job. Investing in real estate is a dying field because limited credit and it takes too much time for such little returns. Spend the time you would by wiping your tennants asses, by spending time with your family and travelling. Have a splendid day, jolly-good sirs!

    Reply
    Post a comment
  • Paul said:
    • 1 year, 1 month

    Great, thanks for the analysis. As a relatively new entry into the Montreal housing market, it is great to have some info and analysis. Obviously I would hope for a prosperous market, but I'm not looking to flip so it is a long-term view.

    Where can we get info by area of the city? Like all cities, certain areas perform better than others. It would be great to be able to get this info somewhere.

    Thanks.

    Reply
    Post a comment
Post a comment