Canada’s long housing cycle is turning. Residential investment stalled last year, as affordability constraints tempered home sales, and builders scaled back the number of new developments, and the sector will remain on a more subdued trajectory over the next several years, imposing a modest drag on output growth, according to a Scotiabank report released today.
Housing is a large and integral part of the Canadian economy. Residential investment, which includes new construction, renovations to existing dwellings, and ownership transfer costs such as real estate commissions and legal and appraisal fees, totalled $128 billion last year. The largest share of investment comes from new construction (45 per cent), followed by renovation spending (37 per cent) and transfer costs (18 per cent).
Housing has been a major driver of growth over the past decade. Residential investment expanded at an average 4.2 per cent annual rate from 2000-2012, almost double overall GDP growth of 2.2 per cent. The sector directly contributed almost 0.3 percentage points annually to real GDP growth over this period. Residential investment accounts for close to a 7 per cent share of overall output — the highest among the G7 economies and more than double the comparable U.S. ratio.
The fastest growing segment has been renovation spending. Fuelled by rising home prices, tight resale market conditions, attractive financing costs and government tax credits, real renovation outlays increased at an average annual rate of over 6 per cent from 2000-2012. This is double the 3 per cent average annual increase in new construction, and three times the 2 per cent yearly growth in transfer costs. These record outlays have increased the quality of the housing stock, and contributed to price appreciation.
Housing also generates significant spillovers to a range of other goods and service industries. Homebuilders and renovators rely on wholesalers and manufacturers to supply building materials, heating and cooling systems, and household appliances and fixtures. New construction requires engineering services for land and infrastructure development. Existing home sales generate substantial ancillary spending for retailers and manufacturers of household goods, movers, and financial and real estate service providers.
Quantifying the size of these indirect economic benefits is challenging, and depends, among other factors, on labour market conditions, the prevailing interest rate environment, and the extent of import leakage. Analysis based on input-output tables has typically yielded an output multiplier of around 1.5, implying a $1 billion investment in housing (through new construction, renovations and/or resale activity) generates a $1.5 billion increase in real output across the economy. Combining direct and indirect impacts, and housing’s contribution to annual GDP growth from 2000-2012 is probably closer to 0.4 percentage points.
These estimates do not account for third-round impacts coming from increases in labour income, or wealth effects from rising home prices. Housing assets have generated $1.7 trillion in net new wealth for Canadian households since 2000. This is a major change from the 1990s, when Canada’s relatively weak housing market generated only $324 billion in household wealth creation. Assuming a wealth effect of five cents to the dollar, this may have generated upwards of $6 billion annually in additional retail, renovation and other household spending.
Housing is labour intensive and a major source of employment for Canadians. The residential building construction sector employed 235,000 Canadians in 2011, including self-employed workers, according to the latest National Household Survey. The real estate services sector counted another 245,000. Related industries, including specialty trade contractors and professional services, employ many more workers. Employment growth in housing-related sectors has consistently outperformed national hiring trends over the past decade by a sizeable margin.
From Less Tailwind to More Headwind
We expect resale activity to edge lower in 2014-2015. Rising mortgage rates, combined with high home prices and stricter mortgage regulations, will strain affordability, especially for first-time buyers in major urban centres. At the same time, population growth and relatively healthy labour market conditions suggest sales should hold near their 10-year average. Softer sales should in turn slow house price appreciation, with greater downside price risk in the more amply supplied high-rise segment than for single-family homes.
A softer sales and pricing environment also is expected to dampen renovation activity. Renovation spending tracks sales transactions, given relatively large outlays undertaken by new buyers and, to a lesser extent, sellers preparing their home for sale. Even so, an expanding housing stock and high homeownership rates should continue to support modest growth in renovation spending. Renovation activity is typically less volatile than new construction and home sales.
Homebuilders are expected to further slow the pace of new home construction in the face of weak growth in new home prices, rising building costs and increased unsold inventory. The slowdown will likely remain focused on multi-unit construction given growing concerns of oversupply and softening investor sentiment. From a regional perspective, Alberta is expected to outperform national trends, with sales and construction supported by relatively firmer employment and income gains and strong population inflows.
The impact of a softening housing market will be felt broadly. Apart from construction, industries most affected by a housing slowdown include manufacturing, retail & wholesale trade, finance, insurance & real estate, and professional & technical services. The likelihood of smaller household wealth gains as house price growth slows (or adjusts lower) will reinforce a more cautious trend in consumer spending.