Rhythm of housing construction slows, improving market’s outlook
One of the hottest sectors in Canada’s generally lacklustre economy, home construction, just keeps getting weaker. This week’s report of new home starts in October fell even more than forecasters had expected. You might think that this is grim news. If so, you’d be wrong.
One of the easiest traps to fall into when looking at such data is to assume that more is always better and less is always bad. Not so. Just as when you’re ordering at your favourite eatery, the trick is to enjoy enough, not leaving the table either hungry or overstuffed.
The analogy with housing isn’t as far-fetched as it might sound: We need enough new homes to supply all the new households in a growing country, not much more and not much less. Too few means that some are poorly housed and prices might rise faster than they should; too many can produce a glut of unsold homes, bankrupt home builders and put downward pressure on prices.
Canada’s rate of household formation over the past five years was 189,000 per year, notes economist Sonya Gulati at the TD Bank, and this is a reasonable estimate of the “appropriate pace of new home construction in Canada.”
Last spring, at the recent peak of activity, we were building homes at a much brisker pace than this. But the rhythm of construction has slowed a lot since new federal curbs on mortgage lending took hold during the summer.
In fact, by October, the pace of housing starts had slowed to just over 204,000. That was down from a high of more than 250,000 early this year.
This does not mean that Canada is heading for big trouble on the housing front, as a few more excitable analysts have been warning for some time. The analogy with recent troubles in the U.S. housing market is just silly.
The more likely explanation is that this decline is just what the doctor ordered for real estate markets. As Carlos Leitao puts it: “I would see this as good news. We were running a real risk of overbuilding.”
But with construction ramping down, that risk is swiftly ebbing, believes Leitao, chief economist at Laurentian Bank Securities.
Others see things in much the same way. “Last spring, I was concerned that we might be seeing broad-based overbuilding,” acknowledges Douglas Porter, deputy chief economist at BMO Capital Markets.
After all, mortgage interest rates then had remained exceptionally low for three years — they still are — leading many to worry that housing, a market that’s very sensitive to the cost of money, might overheat severely.
But the Harper government’s timely reining in of its previously lax rules for mortgage lending seem to have come just in time. Home sales are no longer nearly as buoyant as they were early in the year, although prices continue to advance gradually in most of the country. And with new construction easing off, the danger of a housing glut sparking a price collapse seems remote.
At this point, says Porter, “I don’t think it would take a huge pullback to get housing back in line,” and he’s betting that just such a moderate slowdown is what’s in store. Leitao generally agrees, although he sees home builders pulling back more sharply than does Porter.
In neither case, however, do they see the slowdown in housing as a factor that will torpedo Canada’s economy. Instead, it will be just one more in a series of headwinds that will probably slow the country’s already mediocre growth rate a little more next year. The others are squeezed government spending, especially in high-debt provinces like Quebec and Ontario, and the general tightening of consumer purse strings after years of fairly open-handed spending. The upshot: growth of about 2 per cent or a bit less, down just a bit from this year’s.
The saving grace in this uninspiring outlook, however, is right next door. International trade, which was a major drag on growth so far this year, now shows signs of perking up smartly, led by a resurgent U.S.
Canada’s trade surplus with the U.S. has grown for two months in a row, helping to offset much of the red ink in trade with other parts of the world. Since the market south of the border is our biggest by far, that’s a very encouraging trend, and analysts believe it has a lot of room to grow. U.S. economic indicators have been surprising analysts with their strength, most recently Friday, when the University of Michigan’s survey of consumer sentiment hit its most optimistic level in five years.
“I think that’s the big hope for 2013,” Porter says, even though he concedes that stronger U.S. expansion might be delayed by another agonizing period of political wrangling before Republicans in Congress allow the Obama administration to avoid so-called “fiscal cliff ” of draconian tax hikes and spending cuts. But after that, there’s a decent chance that better times are coming, and that this time, they’ll hang around.