The downside of Canada’s homebuilding boom to be felt in the coming years: report

Think eroding home sales spell trouble for the future of Canadian real estate values? Just wait until a wave of new supply floods the market.

A dire warning from from Capital Economics in a new Canada Economics Update outlines how a homebuilding boom could tip the Canadian housing market from bad to worse. The UK-based economic research firm says tens of thousands of new homes are set to be completed soon in some of Canada’s most expensive markets and that this will exacerbate economic woes.

“While house prices weakness will be painful, the end of the construction boom will have even larger implications for economic growth,” writes Stephen Brown, a senior Canadian economist for Capital Economics.

Brown is aware that by some metrics, Canada’s housing market appears poised for a soft landing. After all, new listings have fallen in tandem with sales, which seems to suggest that homeowners aren’t desperate to cash out.

“The problem, though, is that Canada has been undergoing a construction boom. As has been typical of historic real estate cycles around the world, new supply will reach the market just as demand is falling,” says Brown.

Of all homes completed in Metro Vancouver over the last six months, 7 percent remain unsold. For those who doubt the significance of that share, Brown notes that 40,000 homes are expected to be completed in the area within the next two years. At an unsold rate of 7 percent, that would put unsold units at a record high of 5,500.

While less than 1 percent of newly completed homes remained unsold in November, Capital Economics suggests this rate of absorption can’t be maintained. In fact, the number is largely reflective of market conditions two to three years ago, when these units would have been in the pre-construction phase. “In order to finance construction, condo developers typically sell as many of their units as possible before building begins,” Brown explains.

“New supply will undoubtedly put downward pressure on house prices,” he continues. This, notes Brown, should result in lower consumer spending levels.

“With energy investment also set to contract due to lower oil prices, we see GDP growth slowing sharply and expect the Bank of Canada to cut interest rates at the turn of this year,” writes Brown, doubling down on a previous Capital Economics prediction.

Some may find reason to be skeptical of the Capital Economics prediction. The firm regularly publishes predictions that are at odds with commentary from most market watchers.

Josh Sherman