Canadian real estate prices are rising, but investors are quietly pulling back. In fact, they’re withdrawing their capital at one of the fastest rates in history. Statistics Canada (Stat Can) data shows residential investment dropped sharply in Q3 2021. This is the component of GDP that covers real estate’s most direct economic output. The GDP component recently printed a record, but falling home sales and delayed projects have it spiraling lower.
Canada Spends More Than A Third of Its Investment Capital On New Housing
Canada’s investment in residential structures showed one of the sharpest declines in history. Seasonally adjusted investment fell to $231.2 billion in Q3 2021, down 7.1% ($17.7 billion) from the previous quarter. That second quarter had been the record high for investment in dollar terms.
Canadian Residential Investment
The dollar value spent creating, significantly improving, and trading residential real estate.
Source: Stat Can; Better Dwelling.
The (sorta) good news is fixed capital formation, a measure of total GDP investment, didn’t fall as fast. Residential investment is 39.8% of gross fixed capital formation in Q3 2021. This is a decline of 2.4 points from the previous quarter, underperforming the economy. It peaked in Q1 2021, and the share is now 2.9 points lower from that peak. Canada’s dependence on real estate is starting to loosen, though it’s still very high.
Canadian Residential Investment As A Share of Total Investment
The percent of gross fixed capital formation used to produce or significantly improve housing.
Source: Stat Can; Better Dwelling.
Residential Investment Has 3 Major Subcomponents
Let’s go over where this weakness is coming from by looking at the three big subcomponents. Renovation, the biggest of the subcomponents, is the capital spent on major home renos. New construction is the second biggest and shows the amount of capital sunk into new housing. Ownership transfer costs are the smallest and represent costs associated with trading homes. This is primarily realtor commissions, known as broker revenues. All three segments showed weakness in the most recent data.
Investment For New Housing Made The Sharpest Drop Since 2009
New housing investment is the largest share of residential investment, and it slipped. The segment fell to a seasonally adjusted $102.7 billion in Q3 2021, down 2.6% ($2.8 billion) from the previous quarter. This would be the most significant drop since the beginning of public health measures.
Stat Can made a special note about this segment in regards to the size of its drop. When adjusted for inflation, investment in new housing construction fell 5.7% in Q3. Their analysis shows this is the largest drop for the segment since 2009 — the Great Recession. It really emphasizes the enormous role inflation is playing in this environment.
Canadian Real Investment In New Home and Renovation Change
The seasonally adjusted real quarterly percent change for investment in new home construction and renovations.
Source: Stat Can; Better Dwelling.
Renovation Spending Made The Sharpest Drop Since 1974
Residential renovation spending entered correction territory, even before adjusting for inflation. Seasonally adjusted spending fell to $73.3 billion in Q3 2021, down 11.6% ($9.6 billion) in the quarter. Q2 was also the record high, so a drop at some point was expected.
Unexpected is the size of the drop. It dropped so much, the decline in the month puts residential renovations in a technical correction. The quarterly decline is the biggest since Q4 1974 — before inflation adjustments. Reopen the economy for a minute, and people suddenly don’t all need renovations.
Ownership Transfer Costs Have Officially Crashed
Ownership transfer costs, largely commissions paid to real estate brokerages and land transfer taxes, have officially crashed. That’s technically speaking, of course. Transfer costs fell to a seasonally adjusted $55.2 billion in Q3 2021, down 8.8% ($5.3 billion) from the previous quarter. Last quarter also came in 23.2% ($16.2 billion) lower than the peak reached in the second quarter. A drop of more than 20% in 12 months is considered a crash for those curious about using the term.
Historically, the dollar volume of investment is still very high. Most likely, this has a minimal impact on new supply, especially since it’s higher than pre-2020. Losing $18 billion in spending over a quarter isn’t going to be a painless event, though. That kind of money can’t stop flowing without having an impact.
The drop in housing investment and rise in outflows to foreign markets is worth watching. We knew a pullback for housing investment was coming with the decline in home sales. More capital flowing into foreign securities, like US stocks, also might be showing where the capital went. The BoC argues investors have been driving the market higher. If they divert their capital, it can have consequences for home prices.
After you tap this much investment capital and it’s been replacing income as the household networth driver, where do you get more investment capital from? You need to leverage on top of leverage.
This is either going to fizzle out or we’re going to see some spectacular borrowing against homes to buy more homes.
Agreed.
People are finding out when inflation is 4.7% the yield on these cashflow properties make very little sense. When inflation gets tamed, we might see some more capital come back to pre-sales.
Cashflow negative 2%/year plus a 5% real trim from inflation isn’t attractive to more people? Good thing they’re using leverage.
Investors should have been piling up into consumer goods when sales peaked and some commodities came crashing down. The rise in commodities has to be passed onto basics like food.
Hey Daniel, I’ve been curious about commission for awhile. Perhaps I’m missing something, but it looks to me like commission makes up a small share of ownership transfer costs than some believe.
My back-of-the envelope calculation goes like this: a) 2021 national resales (roughly 625,000) x
b) average sale price (maybe $700,000) x c) commission rate (lets call it 5%) = $21.875 billion a year. New homes need to be added to the mix, so say $25 or even $30 billion total in 2021. This isn’t meaningless, but if OT costs are running at $55 billion per quarter, something else is driving the trend. Any thoughts?