Caution and Uncertainty Continue to be the Keys to the Game

Total Canada-wide housing starts appear to be tracking lower in the second quarter of 2009, with an average for April and May coming in at some 123,000 units, seasonally adjusted at annual rates (SAAR), according to the Canada Mortgage and Housing Corporation. This represents a further 12 per cent decline over first quarter starts, which were down 25 per cent from the fourth quarter of 2008. The good news is that the pattern is up, with May rising almost 10 per cent over April.
Generally speaking, both single-family and apartment starts have been softening    throughout the recession, and this pattern persisted in the first two months of the second quarter.
Regionally, small gains in April and May in Quebec over the first quarter, and larger gains in New Brunswick, P.E.I. and Saskatchewan, were more than overpowered by declines elsewhere. Considering housing starts activity over the first five months of the year, starker regional patterns are emerging. The West is anchoring the slowdown in starts at 67 per cent, 65 per cent and 57 per cent declines year-over-year respectively for BC, Alberta and Saskatchewan. By contrast, Manitoba and Ontario are down more moderately — about 40 per cent year-over-year (about the national average), with Quebec and Atlantic Canada showing the least effects with about 15 per cent declines each. 
Existing home sales markets, by contrast, are generally showing signs of optimism, with the number of Multiple Listing Service sales rising some 30 per cent in April and May (seasonally adjusted) over the first quarter doldrums. Average resale prices are also rising — 4.4 per cent from their February lows (also seasonally adjusted).
Residential renovation spending in Canada reached a plateau in 2008 and has declined about 5 per cent (seasonally adjusted) over the past two quarters. This pause in renovation spending follows a ten-year period of strong steady growth.  

Optimism and Affordability
The stronger interest in the existing home market could bode well for the new construction sector, which is still struggling. A rising resale market suggests a return of consumer confidence and, more specifically, a renewed optimism in the housing sector. Many Canadians are feeling better about the economy, think that the economic downturn may be easing and that the downturn in the housing sector is unlikely to be as severe as in the US.
These confidence factors are certainly playing a role in the resurgence of the resale market, but the current spark is more likely tied to significant improvements in affordability, which might have only a short-term effect, and may already be reversing. The critical five-year mortgage rate was reduced six times and two percentage points between December 2008 and April 2009. In large part, these reductions reflected banks passing on lower funding costs as the financial crisis eased. More recently, some of these improvements in rates have retraced, as mortgage rates follow modest fluctuations in the Canada benchmark bond yield — but in a range of 5.5 per cent to 5.85 per cent posted (and more realistically about 4 per cent to 4.5 per cent after negotiated rate discounts).  Today’s new home buyers are facing better rates now than they have for decades, except for brief spells in 2004 and 2005.
Expectations are primarily for higher rates in the months ahead. Assuming that spreads off of bonds continue to normalize from their financial-crisis heights, expect about a 1.5 percentage point rise in mortgage rates by the end of 2009. 
Affordability has also been assisted by softer home prices, particularly in the new home market where lower construction costs alongside motivations by some builders to liquidate growing (although generally still modest) inventories is leading to more competitive prices.

Economic Realities
Despite the general optimism and rise in consumer confidence in recent weeks, still-weak economic conditions will certainly limit the upside potential for the housing market over the remainder of 2009 and into 2010. Mounting job losses, slower income growth and the loss of wealth associated with the collapse of stock markets will have lingering effects on housing demand, even once the economy begins to grow again later this year.
Moreover, the credit freeze, which put many housing projects on hold over the past six months, is thawing. But generally weaker housing demand will continue to present challenges to new or partly sold developments, reducing the incentives and financing available for new developments.
The expected performance of the Canadian economy over the next several months is of critical importance to the housing sector, and is also fraught with uncertainly. While the springtime has brought some optimism in the form of a rising stock market in particular, and improved conditions in the U.S. banking sector, recent concerns that the U.S. recovery may be further off than expected may stall the nascent confidence on the Canadian side of the border. 
All in all, it is uplifting to see Canadian home buyers opening their wallets in a wave of optimism and confidence this spring. The economic realities of the job market and household incomes will likely make this housing downturn linger a while longer.

Peter Norman is member of the CHBA Economic Research Committee and is Senior Director of Economic Consulting at Altus Group (formerly Clayton Research), a firm of urban and real estate economists.