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Rock-bottom interest rates played a part in people spending big on new properties while stuck at home in the pandemic.Graeme Roy/The Canadian Press

Over decades, real estate has become an increasingly big slice of the economy, taking the mantle of Canada’s largest industry in the 2008-2009 recession as low rates fuelled a lengthy boom period. The pandemic put that trend on steroids.

Before the COVID-19 health crisis, residential investment routinely amounted to 7 per cent of nominal gross domestic product. More recently, that’s surged to more than 10 per cent – or roughly double the equivalent rate in the United States. Stuck at home in the pandemic, people spent big on new properties and renovations, with help from rock-bottom interest rates that were critical to the crisis response.

In a sense, the exuberance for real estate was a bright spot in the darkest days of the pandemic recession, a slight offset to devastation in other parts of the economy. Now, things are shifting. As housing activity cools, the industry has become a drag on an economy that increasingly relies on it.

That was apparent last Tuesday, when Canada posted a shock economic contraction for the second quarter. The key driver was sluggish exports, but housing also had a negative impact. Residential investment fell 3.3 per cent, or at a 12.4-per-cent annualized rate. And further drops are likely coming, given that sales are continuing to ebb in major markets across the country.

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Residential investment “is now such a large slice of GDP ... that it’s likely to act as a drag for some time,” Sal Guatieri, senior economist at Bank of Montreal, said in a note to clients. “Towering nearly 21 per cent above late 2019 levels, the sector is poised to contract in the year ahead as sales moderate in response to fading affordability and as activity corrects from the stratosphere.”

Residential investment is comprised of three areas: ownership transfer costs, new construction and renovations. Transfer costs include such things as real estate commissions and land transfer taxes, and it was this area that entirely drove home investment lower in the second quarter.

New construction and renovations actually managed to increase. At 4.3 per cent of nominal GDP, construction is roughly double its level in the late 1990s, but short of peaks in the mid-1970s. That’s presumably an area in which people would like to see continued growth, owing to housing shortages.

Where there’s scope for a decline is renovations, said Stephen Brown, senior Canada economist at Capital Economics. The pandemic is rife with stories of people rebuilding their decks with pricey lumber, or investing in better home offices. Now, some people are returning to workplaces and spending on activities that were off-limits in lockdowns. “Maybe spending on renovations is going to decline as spending on services picks up,” Mr. Brown said.

Beyond the GDP numbers, the price of homes has accelerated greatly in the pandemic, making it tougher to break into the ranks of homeowners. The national average sale price of $662,000 in July was up 16 per cent from a year ago. For housing skeptics, the national obsession with real estate is a sign of misplaced priorities; that resources could be better allocated to things that enhance our productivity and living standards.

Instead, Canadians have doubled down on mortgage debt in the pandemic, bolstering age-old concerns over the financial health of consumers. In Tuesday’s GDP report, Statistics Canada noted that households added $84.2-billion in mortgages over the first half of 2021, versus $62.3-billion in the second half of 2020. In June, mortgage debt accelerated at the quickest annual pace since 2008.

Housing troubles were a topic of conversation on Royal Bank of Canada’s earnings call in late August. Chief executive Dave McKay said he worried about the bank’s ability to recruit workers with home prices so lofty in major markets. But his concerns ran deeper than that.

“Where I do worry ... is the more cash flow that consumers are putting into housing stock, the less is available to drive the economy,” he said. “I think all policy-makers are worried partly ... about long-term economic drag from that much cash flow going into servicing housing.”

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