Canada's housing market is a topic of perpetual fascination, due in equal parts to its broad reach, the spectacular manner in which it has soared, and fears that it may yet unfold like a classic two-act play: all happiness and light in the beginning, followed by a descent into darkness and regret.
So far, there has been little evidence of encroaching darkness. Home prices rise within a comfortable range of 1 to 6 per cent a year. Household debt-servicing costs are at a multi-decade low and mortgage arrears are low and declining. Affordability is surprisingly normal as plummeting mortgage rates and rising incomes neutralize soaring home prices. Demand seems well aligned with construction and the resale market remains balanced.
Of course, the greatest concerns have always been about what happens later, when mortgage rates normalize. This "medium term" has been a slippery eel, remaining perpetually out of reach as slow economic growth repeatedly delayed higher rates.
Today, however, these medium-term concerns are coming into focus as the U.S. economy strengthens and the Federal Reserve signals rate hikes in 2015. Easily the biggest problem is that Canadian housing affordability looks set to fall as far as 15 per cent as mortgage rates rise. This is a significant blow, even if it is more likely to be resolved over several years through stagnant home prices paired with rising incomes, rather than in a dramatic overnight collapse.
However, other concerns seem exaggerated or misplaced.
The potential construction downside is actually quite tame. While Canada's population growth slows over the next five years, the tilt toward an older population keeps housing demand surprisingly resilient and firmly in the current range of 190,000 to 200,000 newly constructed homes per year.
High household debt levels are not totally consequence-free, but nor do they guarantee doom. It is commonly imagined that Canadian debt levels have ascended to unprecedented and perhaps unsustainable heights. In reality, several other countries survive with far more leverage, including Denmark, whose households have twice the Canadian debt burden.
For that matter, history demonstrates that debt crises have less to do with the stock of debt, and more to do with how quickly and recently it was accumulated. Viewed through this lens, Canada's downside risk has lately shrunk back to normal dimensions.
The number of cranes darkening the skies over Toronto and Vancouver certainly leaves the impression of a vulnerable condo market. In all likelihood, demand and pricing of condos will indeed be somewhat weaker than for other types of housing, as they have been in recent years. But fears are exaggerated, for four reasons.
First, there were unusually few multi-unit residences constructed around the turn of the millennium. Much of the recent spurt represents a catch-up after this prior underbuilding.
Second, we calculate that the overall size of Canada's housing stock is about right, meaning that any assessment of too many condos would necessarily imply too few single-family homes. This is a question of composition, not absolute excess.
Third, condo demand appears to be supported by the pairing of downsizing retirees and anti-establishment millennials (who are rejecting cars and sprawling suburbs to an unprecedented degree).
Fourth, although Canada has twice the normal number of condos under construction right now, it also appears to take twice as long to build them as it once did (this may have to do with the complexities of increasingly tall, downtown structures). These two divergences cancel each other out, resulting in a sustainable, normal flow of completed dwellings.
What about the threat that investors – who by some estimates buy more than half of all new condos – might walk away from a weakening market en masse? This is a risk, but an overblown one. A recent CMHC survey reveals that most condo investors are not highly levered, they take a buy-and-hold perspective and the majority invest for rental income rather than capital gains.
Moreover, the vacancy rate on condo rentals is just 2 per cent, signalling that the units are needed to meet Canada's dwelling needs, regardless of who owns them. It is frankly irrelevant whether the properties are owned by individual investors as in the current arrangement or by institutional property managers in a return to the traditional purpose-built rental model.
All told, housing weakness – mainly due to poor affordability – could slice a quarter of a percentage point annually off Canadian economic growth over the next several years. This is a palpable hit, but nothing like the bloodbath at the end of Hamlet. In fact, the Canadian housing market is arguably hogging more than its share of the limelight, diverting attention from much more relevant actors such as a lower loonie (good), lower oil prices (bad) and a stronger U.S. economy (good).
Eric Lascelles is chief economist at RBC Global Asset Management