Overbuilding of condos in Toronto and other cities is raising the risk of a price collapse that could spread to the rest of the Canadian housing market, the Bank of Canada says.
Developers are building many more homes – particularly urban condos – relative to the size of the population than they typically have historically, the central bank warned in a semi-annual snapshot of the risks facing the Canadian financial system.
"The total number of housing units under construction has been increasing and is now well above its historic average relative to the population," the central bank said.
"This development is entirely accounted for by multiple-unit dwellings (which include condominium units), especially in major metropolitan areas," the central bank said.
Over all, risks to the stability of the financial system remain high, or orange, based on the bank's four-colour rating system. That's the same level as it was in the bank's previous assessment in June.
Much of the report deals with the consequences of a protracted period of low interest rates.
The report also warned that Canada is "vulnerable to a number of interrelated and mutually reinforcing risks." The most significant threat are coming from outside the country, including the outcome of the ongoing "fiscal cliff" negotiations in the U.S. Congress, the euro debt crisis and a Chinese slowdown.
The most significant risks in Canada are excessive household debt and an overheated real estate market, the bank said.
The bank pointed out that household borrowing has slowed and the real estate market has generally cooled since the last report.
But Canadians are still borrowing at a faster pace than their disposable income, and that puts many of them at risks of shocks, such as unemployment or tumbling home prices, according to the bank.
The ratio of household debt to gross domestic product now stands at a record high 163 per cent, up from 161.5 per cent in June.
The report also discusses at length conditions in the Toronto condo market, where the bank says building may be outpacing demand.
"Demand is slowing at a time when the potential supply of unsold units (including those in pre-construction) is still strong," according to the report.
The number of unsold Toronto condo units that are planned, but not yet built, has doubled to 14,000 since June, 2011. The number of unsold units under construction has jumped to 7,000 from 5,000 since the start of the year.
That could put the condo market at risk if buyers dry up, leaving many unsold units, and that could spill over into other areas of the housing market.
Based on discussions with developers, the bank said builders are trying to avoid a glut by postponing and phasing in projects.
But it pointed out that their ability to slow projects is limited by an Ontario law that forces builders to compensate buyers up to $7,500 if units are delivered late.
The bank also pointed out that the average size of new condo units in Toronto is shrinking – to 800 square feet from more than 900 sq. ft. in 2009 – a possible indication that more speculators are getting into the market.
"Greater involvement by investors could potentially increase the volatility of housing prices and sales, under stressed conditions," the bank warned.