This article is a follow-up to Lead Analyst Samuel Kanda's September article, “Commercial Banks Aid Canada’s Housing Market."
Canada’s real estate market has been in one of the largest speculative bubbles since 2002. Following the 2008 recession, interest rates plummeted. In response, Canadian investors invested heavily in residential housing, which caused residential investment to account for an estimated 7.0% of Canada’s nominal GDP. After the onset of the COVID-19 (coronavirus) pandemic and proliferating real estate expansion, residential investment surged to account for more than 10.0% of Canada’s nominal GDP. For context, the United States’ residential investment percentage of nominal GDP is expected to account for 4.8% in 2021.
Too many eggs in one basket
As displayed, the Canadian economy has become increasingly reliant on the overall health of the real estate market, more so than its neighboring trading partners. During the second quarter of 2021, this overreliance backfired as the overvalued Canadian housing market begun to cool. Moreover, the country’s has experienced lackluster export growth during the quarter, substantially contributing to the economic contraction.
Since prior growth in residential investment is unsustainable for a long period of time, once the housing market begins to stabilize, it will likely place a large strain on Canadian GDP, causing GDP to contract 0.3% during the second quarter of 2021. This is also troublesome since the federal government has instilled a plethora of economic recovery programs due to the adverse effects of the coronavirus pandemic.
The rapid rise in residential investment also poses a potential threat to Canada’s money supply. Since the Canadian house price index has increased an annualized 4.3% over the five years to 2021, Canadians are tying up more of their money in real estate and taking on more mortgage debt. According to Statistics Canada, Canadians took on $62.3 billion of residential mortgage debt during the second half of 2020 and then an additional $84.2 billion during the first half of 2021 alone. As consumers continue to put more cash into housing stock, less cash flow is available to drive economic expansion.
Why is the market declining?
Residential investment is composed of three parts, which includes new construction, renovations and ownership transfer costs. Although new construction and renovation expenditures continuously increased starting during the third quarter of 2020, ownership transfer costs have endured a massive decline, falling 17.7% during the second quarter of 2021. This decrease came as demand for housing contracted after the uptick in demand for houses when more people began working from home due to the pandemic. Overall, as the market begins to slowly return to equilibrium, it will likely hinder Canada’s economic growth over the five years to 2026.
