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.
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.