Residential Construction Slowdown, Despite Buoyant Housing Market

BMI View: We are maintaining our outlook for Canada's residential construction sector to continue to experience a gradual, but uneven, slowdown. As anticipated, the housing market has accelerated in the second half of 2013, with house prices and mortgage lending remaining buoyant. However, we do not expect this to prevent the continued slowdown in new residential construction, as developers remain focus on inventory reduction. Consequently, we have further downgraded our residential and non-residential growth rate for 2013 and 2014.

The residential building sector has been a positive contributor to overall construction sector growth in Canada; however, we anticipate this trend to dissipate in 2013. Leading indicators suggest that the residential construction market is struggling to reach previous highs, and therefore we expect the industry to contribute far less to the overall construction sector than over recent years. In line with equally unimpressive growth in the non-residential construction sector, we have further downgraded our outlook for residential and non-residential building net output to 0.7% in 2013, and expect growth to remain below trend in 2014 at 1.6%.

New Construction Slowing First

Residential Unlikely To Contribute
Construction Industry Sub-Sectors, Real Growth, % y-o-y

BMI View: We are maintaining our outlook for Canada's residential construction sector to continue to experience a gradual, but uneven, slowdown. As anticipated, the housing market has accelerated in the second half of 2013, with house prices and mortgage lending remaining buoyant. However, we do not expect this to prevent the continued slowdown in new residential construction, as developers remain focus on inventory reduction. Consequently, we have further downgraded our residential and non-residential growth rate for 2013 and 2014.

The residential building sector has been a positive contributor to overall construction sector growth in Canada; however, we anticipate this trend to dissipate in 2013. Leading indicators suggest that the residential construction market is struggling to reach previous highs, and therefore we expect the industry to contribute far less to the overall construction sector than over recent years. In line with equally unimpressive growth in the non-residential construction sector, we have further downgraded our outlook for residential and non-residential building net output to 0.7% in 2013, and expect growth to remain below trend in 2014 at 1.6%.

Residential Unlikely To Contribute
Construction Industry Sub-Sectors, Real Growth, % y-o-y

New Construction Slowing First

Despite house price growth remaining strong, and mortgage lending ticking up in the latter half of 2013, the residential construction market has remained below previous highs. In line with expectations, the Canadian housing market has corrected following a period of weaker growth in late 2012 and into 2013. Whilst the government's most recent efforts to dampen the housing market - in mid 2012, the government announced measures that included mandatory mortgage insurance for lenders with a deposit below 20% and a reduction of the tenure of government-backed mortgages to 25 years from 30 - weighed down the market for a 6-12 month period, these effects have worn off over recent months. Despite tightening mortgage lending rules four times since 2008, mortgage lending continues to grow at a rapid pace, with mortgage credit expected to reach CAD1.24trn by the end of 2014 (according to the Canadian Association of Accredited Mortgage Professionals), compared to CAD940bn in Q2 2013. At the same time, house prices have consistently reported around 8.5% y-o-y growth since July 2013, according to CREA.

Still Supporting The Housing Sector
Mortgage Lending Rate (five year term), % (LHS) And Mortgage Credit, CADmn (RHS)

However, even though the overall housing market is rebounding from the slump in the latter months of 2012 and first half of 2013, the residential construction industry remains below previous highs. This lack of residential building activity indicates that a slowdown has taken hold at least in the new build market and the industry is stabilising at a lower level. Indeed, new home sales are ticking up at a much slower rate than existing home sales, and fell by 0.7% y-o-y in October 2013 (versus 8.3% growth in existing sales).

As a number of large new housing projects, especially in Toronto, draw to a close, we do not expect new projects to be proposed in anywhere near the same volume as before. Indeed, developers are likely to focus on reducing inventory, as inventory levels have ticked up over recent months. This trend is reflected in the data. Housing starts have stabilised around the 185,000-195,000 level. This is far off the peak in May 2012 of 252,000, but somewhat recovered from the troughs in early 2013 (housing starts had fell to a low of 161,000 in January 2013). Moreover, residential building permits remain significantly off peak growth (following 15.5% growth in the first nine months of 2012), averaging -3.4% for the first nine months of 2013. Although somewhat recovered from double digit contraction in the first half of 2013, permits remain in negative territory. Finally, output in residential construction is flat for 2013 (compared to 7.5% y-o-y growth in the first nine months of 2012), indicating that it will contribute its lowest level to the overall construction industry since 2009.

Pipeline Slimming Down
Residential Building Permits, CAD'000s And % Change y-o-y

Whilst we anticipate the slowdown in new construction to continue into 2014, we remain confident that the Canadian housing sector in general will not experience a full-blown crisis. Canadian banks have, by and large, engaged in safe mortgage lending practices even through the boom, especially relative to the US. Furthermore, monetary policy is likely to remain accommodative for a substantial length of time, particularly if house prices begin to fall significantly. Although mortgage lending rates have ticked up over recent months, they remain accommodative, especially versus historic averages.

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This article is tagged to:
Sector: Infrastructure, Real Estate
Geography: Canada
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