March 3, 2005

SPECIAL REPORT

Economist says party is over

Residential market expected to cool off

This is the second in a series of three articles on an annual economic outlook produced by Reed Construction Data.

By Grant Cameron

staff writer

Canada’s once red-hot housing market could be running out of steam.

An annual outlook released recently by Reed Construction Data indicates that demand for housing in 2005 will likely continue to erode.

“The outlook for Canada’s housing market in 2005 can be captured in a fairly simple phrase: ‘The party’s over,’” Alex Carrick, chief economist at CanaData, Reed’s Canadian economic forecasting and statistical service, writes in the outlook.

“After three very strong years, housing demand — as it typically does in a mature expansion — is starting to cool.

“The demand pressures of the late 1990s have almost completely deflated in 2002 to 2004.”

Carrick says high home affordability, a climate of relatively strong consumer confidence and a desire by some first-time homebuyers to take advantage of low mortgage rates before they increased, all supported the housing market early in 2004.

However, housing demand then started to weaken due to flagging pent-up demand and a shrinking pool of second-time homebuyers, he says.

“The clearest sign of the softening in housing demand is the fact that sales of existing homes have steadily slowed since the first quarter of 2004,” he says, “even though mortgage rates in August of this year were 35 basis points lower than they were in January 2004.”

Carrick expects that housing demand for the country as a whole will likely continue to erode for a number of reasons.

First and most importantly, he says, the pool of first-time homebuyers has dropped sharply compared to 2002, which will hurt existing home sales, since a majority of existing homes are purchased by first-time homebuyers.

The number of existing homeowners, many of whom decided to move in 2004, is also likely to shrink in 2005 and beyond, he says.

Meanwhile, higher oil prices, higher interest rates and increased uncertainty about the near-term outlook is likely to unsettle homebuyers, causing them to take their time before changing their addresses, he says.

While Carrick expects both higher interest rates and weaker pent-up demand to slow housing demand in 2005, he says it should also be supported by stronger growth of full-time employment and the likelihood of retreating energy prices at some point in the year.

However, he adds, eroding affordability and a shrinking pool of move-up homebuyers will depress ownership demand, affecting the mix of new dwelling construction in 2005 and beyond.

Moving forward, he says, rental demand is likely to strengthen due to an increase in first-time renters but it is unlikely to trigger significant rental construction until the excess inventory of vacant rental space is absorbed, probably in late 2005 or early 2006.

Regionally, Carrick says British Columbia, Quebec and Manitoba each exhibited an acceleration in housing demand in 2004.

He notes that Ontario has also seen strong new house construction over the past three years, but rising house prices due to higher mortgage rates and lacklustre growth of disposable incomes will cause home affordability to deteriorate in 2005.

“Consequently, housing starts in the province will probably fall disproportionately more than in the country as a whole.”

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