Canadian real estate has outgrown productive investment for a few years, but it’s never been this bad. National Bank of Canada (NBC) found that Canadians now invest more in homes than businesses. It’s the first time since the early 1960s that housing investment has grown larger than private investment. The “Big Six Bank” says this has forced domestic pensions to put most of their cash to work abroad. If this continues, they warn Canada will have a severe capital flight issue.
Fixed Capital Stock
Fixed capital stock is the accumulation of material and immaterial investment assets. It breaks down into two major segments, non-residential and residential.
Fixed non-residential capital stock is things like machinery and factories. It’s capital to earn or facilitate creating more productivity. That’s why it’s often called productive investment. Non-residential capital is welcome since the greater economic output is generally good.
Fixed residential capital stock is the country’s investment in housing. It includes capital sunk into building new homes and major renovations. It’s where your country’s labor lives. The issue is that it’s a non-productive asset and does minimal to grow an economy continually.
Non-productive investment can do the opposite of grow an economy, tbh. It diverts money into servicing debt, which otherwise would have been spent in the economy or invested. Since debt is an IOU to claim wages from workers’ future productivity, it slows future growth.
An economy needs places to live and resources to conduct work, so healthy investments in both segments are required. However, it becomes an issue when residential investment absorbs more capital than non-residential. In this scenario, people put more money into where they live than resources for conducting work. That is what’s happening in Canada.
Canadians Are Investing More In Housing Than Business For The First-Time Since 1961
Canadians now devote more capital to housing than private investment. The total capital stock reached $5.5 trillion in 2020, with just over half in residential investment. Residential represented $2.8 trillion, and non-residential was the remaining $2.7 trillion. Stat Can said this is the first time this scenario has occurred since 1961. That was the year they started tracking it, so it may go back much further. This time really is different.
Canadians Are Investing More In Housing Than Private Businesses For The First Time Since 1961
Canadian net fixed residential and non-residential capital stock.
Source: Statistics Canada; Better Dwelling.
Canada Has Been Heading In This Direction For The Past 5 Years
The year 2020 was exceptional, but this trend began much before last year. It actually goes back to when the US Federal Reserve declared Canadian real estate a bubble. “Growth-enhancing investment is lagging in Canada, a trend that was evident even before the pandemic… While the pandemic most certainly exacerbated this decline, we note that the 5-year moving average has been on a downtrend for several years,” said NBC’s chief economist, Stefane Marion.
Canada Is Risking Capital Outflows
“Whatever the cause of this lack of private investment, we must turn it around. Canada is very dependent on foreign money to finance its current account, which is likely to return into a deficit in 2022. If our growth prospects look unattractive in a post-pandemic world, capital flight could ensue,” he warned investors.
When housing is soaking up the majority of capital, little is left to conduct business. Either there’s too little incentive to invest, corporate bonds yield too low, or consumer spending is minimal. It creates an unattractive environment, especially while other economies hit their stride.
As an example, Marion points to Canadian pensions lowering their investment exposure in Canada. By his calculations, domestic pensions had 90% of their assets in the country in the early 1990s. That share is now less than 30%, including a 10 point drop since 2020. Obliterating the fixed income markets has also sent institutions looking for risk abroad.
“Clearly, we are not doing very well when our own domestic pension funds prefer to invest heavily abroad rather than in Canada,” he adds.
Combine this data with a sharp drop in self-employment across Canada, and you might start to understand the issue. It’s hard to convince people to build a company when homes return 20% annual gains. The government also provides leverage and subsidizes debt to invest in this area. It’s doing this after backstopping any adverse outcomes throughout 2020. Few people even believe home prices could fall due to the moral hazard created.
Why start a business or fund a company when you can make more in housing? That’s the question more people are asking themselves, and an absence of business investment is the result. Investing in an economy is riskier than investing in housing. Apparently, people don’t have to work. They can just trade homes back and forth.