Canada’s housing market giveth and taketh away. BMO senior economist Sal Guatieri dropped some notes on plummeting residential investment today. The segment of gross domestic product (GDP) fell so fast in Q2 2021, it held the whole economy back. The bank warned this is just the beginning for housing investment, as it comes back to reality. As it does, it should be a drag on the general economy for the next few years.
Canadian Housing Investment Declines Over 12%
We already discussed the GDP contraction today, but didn’t dive into residential investment. The segment printed an annualized decline of 12.4% in Q2 2021, dragging total GDP lower. After exports, it was the largest reason behind the economy’s pull-back. “Despite more home building and renovation spending, the segment fell due to a retreat in ownership transfer costs, as sales pulled back from record heights,” he wrote.
Residential Investment Is Over A Tenth of Canada’s Economy
Housing has been consuming more and more of the Canadian economy over the past few years. It now represents so much business activity, just residential investment is 10.1% of GDP. That’s right, building and renovating homes consume over 1 in 10 GDP dollars. BMO calculations show this is 4.2 points higher than the long-run average. For context, the US housing bubble, which wrote the book on bubbles, peaked at 6.7% of GDP in 2006. Economists still debate how an economy became so dangerously dependent on housing. Amateurs.
Source: BMO Capital Markets.
Experts warn high ratios of residential investment will drag economic growth. After all, a huge amount of resources are put into warehousing people. “The report is a timely reminder that the housing sector is now such a large slice of GDP, that it’s likely to act as a drag for some time,” he said.
Canada’s Housing Slowdown Will Be A Drag On The Economy
Pandemic-driven low-interest rates and quantitative ease (QE) accelerated home buying. As the demand that was pulled forward catches up, a buying gap is likely to appear. This is where the pulled-forward buyers would have bought without lower rates.
These are typical market mechanics, before adding the end of QE and possible rate hikes. The end of QE is widely expected, which would lead to less credit liquidity (and higher mortgage rates). This does the opposite of a rate cut, pushing buyers further out.
Increasing interest rates becomes less likely as economic growth slows. Though, if inflation is stubbornly high, it can force their hand to raise rates. A combination of high inflation and weak growth is deadly to economies.
Then there is the impact of high home prices, and the fact it’s unaffordable. If only a small percentage of people can afford to buy a home, it becomes difficult to continue to drive demand. Higher home prices reduce qualified demand. “Towering nearly 21% above late 2019 levels, the [residential investment] sector is poised to contract in the year ahead as sales moderate in response to fading affordability and as activity corrects from the Stratosphere,” said BMO.
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