A Great Way to Start 2006
By Dr. Peter Andersen

Construction-friendly weather and a catch-up with backlogged permit applications will keep new home builders very busy through the first half of 2006. There was a massive jump in residential building permits in December. A desire to avoid higher 2006 development charges and permit fees was also behind the spike in building permits. Multi-family projects in Toronto were a big contributor. Ontario, Alberta and B.C. all show new all-time monthly highs for permits.
On a national basis, residential building permit values were up by a spectacular 41 per cent in December from the month before. Both single-family and multi-family values hit new peaks. The value of multi-family permits more than doubled between November and December and at year-end stood more than 50 per cent above the previous high set in June 2004. The value of single-family permits showed a very solid month-to-month increase of nine per cent in December, narrowly eclipsing the previous December 2004 record.
Given the very short time lag between housing starts and building permits, housing starts have reflected this huge surge in permits and were much stronger than expected in December and January. They increased to 247,900 units in January, measured at seasonally adjusted annual rates, up from an upwardly revised 232,600 units in December.

A revival in single-detached starts
While single and multiple seasonally adjusted starts rates both increased in January, the monthly increase in single-detached starts was a standout. This category showed a 14 per cent monthly increase and single starts rose to their highest level since January 1990. This is a very welcome development as there has been an undercurrent of concern in the housing industry because large declines in single-detached starts were recorded in some markets last year despite a very positive interest rate environment.

Widespread regional strength
The January strength in urban area housing starts was distributed quite evenly across Canada. British Columbia was the only region to show a seasonally adjusted monthly decline but on a year-over-year basis it is still up by 20 per cent for total starts and 35 per cent for single starts. Atlantic Canada shows a very sharp increase in January activity. Atlantic region multiple starts were three times higher than in January 2005.
Ontario, Quebec and the Prairie region all showed monthly gains in January. Using year-over-year comparisons, Quebec does not look as strong as Ontario. Quebec starts are basically flat with January 2005 for both singles and multiples. Ontario looks much better with a 35 per cent yr/yr increase in total starts, with the weighting on multiples, up by 70 per cent vs. 10 per cent for singles. In the Prairies, mild weather in Alberta was a factor behind a 64 per cent yr/yr January increase in singles. However, multiples showed double-digit yr/yr declines in both Calgary and Edmonton. Saskatchewan had a stellar January for single detached starts, with the number more than 2-1/2 times larger than in January 2005. Manitoba shows a 31 per cent yr/yr starts increase concentrated in singles.

New home prices increasing
New home prices are moving up a bit faster now. The national average was up by 5.9 per cent yr/yr in December, compared to 5.5 per cent the month before. Rising building materials prices and higher labour costs are increasingly important issues for new home builders.
However, the national average is misleading as the upward pressure is concentrated in specific markets, mainly in Western Canada. New house prices in Calgary are up by 19 per cent yr/yr. Winnipeg prices are up by 10 per cent and Edmonton prices by 9 per cent. In comparison, new house prices in Ontario show a much different picture, with yr/yr increases running at around 4.0 per cent in most centres.

Caution advised
Home builders and building supply manufacturers will have to be careful in interpreting the latest building permit and housing start numbers. They look deceptively strong because of the unusually warm winter and the bunching-up in building permits. The high levels of starts activity in the first quarter represents a pulling forward of starts that would have taken place later in the spring. They will be at the expense of lower starts later in the year.

Housing demand has peaked
Our forecast continues to be based on the notion that a basic downtrend in housing demand is underway in Ontario and Quebec. It is being partly obscured by robust housing activity in Alberta and British Columbia and by the extended cycle in investor condo demand in Toronto. Canada is still several years behind the U.S. housing cycle and will not experience for some time yet the kind of evolving slowdown that is in place in the United States. Nonetheless, Canadian builders should be aware that their American counterparts are facing ebbing demand and are responding by trimming prices. Our current forecast is for approximately 207,000 housing starts in Canada in 2006, down from 225,481 in 2005.

Fed rate pause now doubtful
The outlook for interest rates and the Canadian dollar will be a key determinant of housing demand. We are skeptical of the generally accepted view that the Fed will enter into a rate pause this spring. Given our forecast for strong growth in the U.S. economy, Fed Chairman Bernanke could keep on tightening. The Bank of Canada would likely follow, with the end result being significantly higher rates for short-term mortgages and also a move in the business prime landing rate up to around 6.25 per cent or higher by year-end.

Canadian dollar playing an important role
The Canadian dollar will have a double-edged impact on housing demand. A C$ in the 87- to 90-cent (U.S.) range will dampen inflation in Canada and could rein in Bank of Canada rate increases this summer and fall. However, this would likely have a significant negative effect on employment, especially in manufacturing centres in southern Ontario. We have always emphasized the importance of a strong job market for housing demand.

Risks in Ontario and Quebec
A final forecast issue is the distribution of housing start activity in 2006. Our starts forecasts for Ontario and Quebec are weaker than consensus at 69,000 and 44,000, respectively. However, Alberta and British Columbia have the potential to surprise us again on the upside. We are not forecasting it yet but Alberta could have another year with starts in excess of 40,000 and starts in B.C. could move well above 35,000 units. The national starts number therefore might look deceptively stable given these offsetting influences.

Long-term interest rates staying low
Longer-term interest rates are set by market forces rather than by central banks. The best way to predict where the five-year mortgage rate is going is to have a good forecast for longer-term government bonds. The place to start is the U.S. bond market and the best rate to follow is the yield on the ten-year U.S. Treasury note. It has confounded experts by staying remarkably stable, even though short-term rates have been rising.
We have heard forecasts of rising long-term interest rates for more than a year now but they have not materialized. We think that there is a reason for this and that systematic forces are at work, which will keep them close to where they are now. There seems to be a global savings glut which is being funneled into long-term U.S. Government bonds, keeping rates low.