Home Economy A hard stop in housing spells trouble for the economy

A hard stop in housing spells trouble for the economy

by SuperiorInvest

Where it goes, the rest of the economy usually follows

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Brace yourselves: after a long bull run, Canada’s housing market is on the mend.

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This is as clear on the street as it is in the numbers. The units are listed further. Bidding wars are now rare. Prices are falling. Housing dominates conversations at the community center, the water cooler, networking events, social media, and of course the conference Q&A.

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

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Housing is like economic fun. First and foremost, it’s probably the one asset in the system that we can all relate to. Second, most of the average Canadian’s wealth is tied up in it. Third, there has been a surge in home buying over the past two years as prices have soared and buyers fear being left behind. The most vulnerable to a correction are peak purchases – especially by first-time buyers. Fourth, consumer debt is among the highest in the Organization for Economic Co-operation and Development (OECD) countries at 185 percent of income and has increased by 29 percentage points since 2007. Most of this is mortgage debt.

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The list goes on. Fifth, in a period of low interest rates, more buyers opted for variable rate mortgages and faced instant resets with interest rate spikes this year. Changes in housing market conditions – particularly sales prices – are a nasty double whammy for recent homebuyers. The list could be longer, but one more: housing is a key indicator of economic activity. Where it goes, the rest of the economy usually follows. Recent home buyers won’t be the only ones reeling; they are simply the first to feel it.

The numbers released on January 16 by the Canadian Real Estate Association (CREA) are sobering. Existing home sales fell 21 percent in the second quarter of this year, then 14 percent in the third and another five percent in the fourth, bringing the year as a whole down 38 percent. Granted, this comes after an extraordinary increase in 2020-21, but sales levels are currently 16 percent below the three-year average before the pandemic. To put it another way, current sales have only been this deep below the 10-year average twice since 2007, and the wedge is currently comparable to what we experienced in the 2009 recession.

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And then there are the prices. At first glance, CREA’s numbers don’t look terrible. Prices are down 7.5 percent year-over-year, which leaves things pretty elevated given the previous huge increase. Moon movements paint a very different picture. Since the peak in February, Canadian-wide prices are down 13 per cent and the annual rate of monthly decline was 17 per cent in December. It’s getting serious. Then consider that prices would have to fall a total of 21 percent just to return to the normal trend. Some regional numbers are much stricter. Even darker, this year’s interest rate hikes are likely to have negative effects on the housing market that will stretch through at least early 2024.

New home construction seems to strongly disagree. Unlike the market in the United States, housing starts in Canada are on a tear. This may be due to temporary factors. Last year there was a very unusual increase in the number of people without permanent residence, a large number of whom were Ukrainian immigrants fleeing the war. This is expected to continue to boost construction activity in 2023 as there were over 135,000 land and air arrivals from Ukraine in 2022, while the latest number of approved applications is over 470,000.

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Another key source of temporary demand is the crowd of waiting buyers: those who have delayed their first purchase in the hope of lower future prices. This could further boost demand for new builds, although potential buyers could wait for the downturn to end. Public programs aimed at rapid creation of new units will also create a temporary demand for new construction.

The conflict between existing and new home markets, typically perfect substitutes, is a puzzle. However, the solution may simply be timing. Builders are under intense pressure to go hard while the market is hot. But buying land, zoning it, clearing it, servicing it, promoting it, and then you start building takes time. If you want a house now, it’s probably easier to buy an existing one—which suggests that this second market is a better indicator of actual immediate market conditions.

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Price movements in the market must also be taken into account. Average annual gains of 20 percent in 2020 and 2021 — which, by the way, outperformed the S&P500 — went unnoticed, enticing even the most novice of speculators to get in on the action. The current price slump, fueled by rising interest rates, likely also reveals a market that has been operating well beyond true fundamentals for a number of years.

If misery loves company, we are almost out of luck. While interest rates are rising almost everywhere, housing markets are not responding in the same way as Canada’s. Of the 14 countries included in the Oxford Economics study from the end of last year, the housing price correction in Canada is the largest, with only Sweden and New Zealand coming close. Their peak-to-trough forecast sees Canada down 30 percent, New Zealand down 28 percent, Sweden down 20 percent and Australia and the United Kingdom down 11 percent. All others are in the single digits, averaging a relatively modest four percent correction. We are clearly more outliers at the wrong end of the distribution.

If housing is still a reliable leader of the broader economy—and there’s no good reason to believe it isn’t—then the troubling weakness at the leading edge of this savvy market portends trouble. I sincerely hope that those confidently predicting a slight correction are correct. I’m afraid something much worse is in store for us.

Peter Hall is the CEO of Econosphere Inc. and former Chief Economist of Export Development Canada.


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