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  • Peter Hall

Housing's hard stop spells trouble ahead for the economy

Brace for it: after a long bull run, the Canadian housing market is correcting.

Sales of existing dwellings in Canada fell 38 per cent last year, according to the Canadian Real Estate Association.

This is as plain on the street as it is in the numbers. Units are listing for longer. Bidding wars are now rare. Prices are tumbling. Housing dominates conversations at the community centre, the water cooler, networking events, social media and of course, conference Q&As.

Is this just another transitory jarring jolt to the economy, or is there more to the story?

Housing is like an economic funny bone. First and foremost, it’s likely the one asset in the system we can all relate to. Second, most of the average Canadian’s wealth is tied up in it. Third, there was a rush of home purchases in the past two years as prices surged and buyers feared getting left behind. Purchases at the peak — especially by first-time buyers — are the most vulnerable to a correction. Fourth, consumer debt is among the highest in the Organization for Economic Co-operation and Development (OECD) countries at 185 per cent of income, and has surged by 29 percentage points since 2007. Most of that is mortgage debt.

The list goes on. Fifth, in the low-interest period, more buyers opted for variable-rate mortgages, and they have faced instant resets with the sharp rise in interest rates this year. Changes in housing market conditions — especially selling prices — are like a nasty double-whammy for recent homebuyers. The list could be longer, but here’s one more: housing is a key leading indicator of economic activity. Where it goes, the rest of the economy usually follows. Recent homebuyers won’t be the only ones to get jolted; they are just the first to feel it.

Numbers released on Jan. 16 by the Canadian Real Estate Association (CREA) are sobering. Sales of existing dwellings fell 21 per cent in the second quarter of this year, then 14 per cent in the third and a further five per cent in the fourth to bring the year as a whole down by 38 per cent. True, this comes after an extraordinary surge in 2020-21, but sales levels are currently 16 per cent below the three-year pre-pandemic average. Through another lens, current sales have only been this far below the 10-year average twice since 2007, and the wedge is currently comparable to what we experienced in the 2009 recession.

And then there are prices. On the surface, CREA’s numbers don’t look awful. Prices are down 7.5 per cent year on year, which, given the huge prior increases, leaves things pretty elevated. Monthly movements paint a very different picture. From the peak in February, pan-Canadian prices are down 13 per cent, and the annualized rate of monthly decline was 17 per cent in December. That’s getting serious. Then consider that prices would have to fall by a total of 21 per cent just to get back to a normal trend. Some of the regional numbers are a lot more severe. Even more sombre, this year’s interest rate increases will likely have negative effects on the housing market that stretch at least into early 2024.

New homebuilding activity seems to strongly disagree. In contrast to the United States market, housing starts in Canada are on a tear. Temporary factors might be the reason. Last year there was a highly unusual surge of non-permanent residents, a large portion of which were composed of Ukrainian immigrants fleeing war. This is expected to continue boosting building activity into 2023, as over 135,000 arrivals from Ukraine by land and air occurred in 2022, while at latest count, approved applications number over 470,000.

Another key source of temporary demand is the buyer-in-waiting crowd: those who deferred their first-time purchase hoping for lower future prices. These could stoke demand for new builds further, although prospective buyers might well wait until the plunge is over. Public programs aimed at rapid creation of new units will also create temporary demand for new builds.

The conflict between the existing and new home markets, typically perfect substitutes, is a puzzle. However, the solution might simply come down to timing. Builders are under intense pressure to run hard while the market is red hot. But it takes time to buy land, zone it, clear it, service it, promote it, and then get on with the building. If you want a house now, it’s likely easier to buy an existing one — suggesting this latter market is a better indication of true, immediate market conditions.

The market’s price movements also need to be taken into consideration. Average yearly gains of 20 per cent in 2020 and 2021 — which incidentally outstripped the S&P500 — escaped no one’s notice, tempting even the most novice of speculators to get in on the action. The current price plunge, abetted by rising interest rates, likely also reveals a market that for a number of years has been operating well beyond actual fundamental requirements.

If misery loves company, we’re almost flat out of luck. While interest rates are rising just about everywhere, housing markets aren’t reacting the same as Canada’s. Of the 14 countries covered in an Oxford Economics study late last year, Canada’s housing price correction is the largest, with only Sweden and New Zealand coming anywhere close. Their peak-to-trough forecast has Canada falling 30 per cent, New Zealand down 28 per cent, Sweden declining 20 per cent and Australia and the U.K. each shedding 11 per cent. All the rest are in the single digits, averaging a relatively mild four per cent correction. We are clearly the outlier at the bad end of the distribution.

If housing is still a reliable bellwether of the broader economy — and there’s no good reason to believe it isn’t — then alarming weakness at the leading edge of this prescient market spells trouble ahead. I earnestly hope that those who are confidently predicting a mild correction are right. I fear we are in for something much worse.



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