Canada's Housing Bubble

Jun 08, 2011 Sunny Freeman The Canadian Press

TORONTO — A pickup in May housing starts suggests that demand remains healthy, but economists say sky-high prices and an overbuilt condo market are setting the stage for a construction downturn.

The seasonally adjusted annual rate of housing starts was 183,600, up from 178,700 in April, according to a report by Canada Mortgage and Housing Corp.

"Housing starts increased modestly in May due to an increase in multiple construction in most provinces and in rural starts," said Bob Dugan, chief economist at CMHC's Market Analysis Centre.

"The increase in multiples and rural starts was partly offset by a decrease in single starts."

Multiple unit buildings have outpaced single unit starts by an average of about 30,000 units over the past year, said BMO economist Robert Kavcic.

"The preference appears to be toward smaller, more affordable units, especially in the expensive B.C. and Ontario markets," he wrote in a note.

The increase in new urban condos came even as some economists have been warning about an overbuilt condominium sector — especially in big cities like Toronto and Vancouver — that could cause a glut of supply on the market, exacerbating the impact of any downturn.

The housing market has already showed signs of slowing, but home prices remain sky-high, reaching a national average of $372,544 in April. Prices are outpacing income and job growth and that, combined with elevated levels of household debt, is putting a squeeze on homeowners.

Economists believe that some Canadians are able to carry the load as both long-term and variable rate interest rates remain low. They warn that there could be a big drop in housing prices when interest rates rise and owners find it more difficult to own such pricey homes, which could lead to a sell off and a drop in home prices.

Some have even predicted prices could fall as much as 25 per cent in the next year.

The Bank of Canada is expected to increase its overnight lending rate — the rate that banks use to set their prime lending rate for consumers — meaning homes will become harder to afford, sparking a pullback in buying activity, said TD Bank economist Francis Fong.

"With the Bank of Canada set to raise interest rates later this year affordability will weaken further, putting downward pressure on overall prices and, thus, construction activity," Fong wrote.

"TD Economics anticipates housing starts to run below their long-run sustainable level over the next few years as multi-unit building slowly unwinds."

CIBC World Markets economist Krishen Rangasamy said housing starts reached a peak of around 200,000 in the first quarter of last year and the numbers have been on a gradual decline ever since, even with low interest rates.

"And with a recent softening in the pace of existing home sales, the listing to sales ratio rose to a seven-month high in April. So, we may see some softness ahead for housing," Rangasamy said.

"We expect housing starts to continue to soften — a 10 per cent or so drop in starts compared to last year — as home prices stagnate in light of higher interest rates in the second half of the year."

But Kavcic noted that housing starts so far this year are about in-line with the annual rate of household formation.

"After a strong post-recession sprint, residential construction activity in Canada seems to have settled down at a sustainable level consistent with underlying demand," he said.

"Housing shouldntt be much of a driver nor much of a drag on growth in 2011."

In the most recent CMHC report, urban starts increased 0.8 per cent to an annual rate of 161,000 units in May. Urban multiple starts were up four per cent to 100,000 units, while single urban starts fell 4.1 per cent to 61,000 units.

May’s annual rate of urban starts increased 33.3 per cent in British Columbia, 13.5 per cent in Quebec, 11 per cent in the Atlantic region and 10 per cent in the Prairies. Urban starts fell 22.9 per cent in Ontario.

Rural starts were estimated at a seasonally adjusted annual rate of 22,600 units in May.

Earlier this week, Statistics Canada reported that the value of building permits fell to $5.3 billion in April, a 21 per cent decline from March when municipalities issued $6.8 billion in building permits, the highest figure since June 2007.

Building permits are a signal of contractors' intentions and foretell trends in the housing and construction markets.

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