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National Bank of Canada_State of Residential Construction in Canada_Economics Weekly

National Bank of Canada_State of Residential Construction in Canada_Economics Weekly

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State of Residential Housing Construction in Canada
State of Residential Housing Construction in Canada

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Published by: jdtremblay.frenette9588 on Aug 10, 2010
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August 6, 2010
ECONOMY AND STRATEGY GROUP – 514.879.2529Stéfane Marion,
Chief Economist and Strategist
: National Bank Financial (NBF) is an indirect wholly owned subsidiary of National Bank of Canada. National Bank of Canada is a public company listed on Canadian stock exchanges.
The particulars contained herein were obtained fromsources which we believe to be reliable but are not guaranteed by us and may be incomplete. The opinions expressed are based upon our analysis and interpretation of these particulars and are not to be construed as a solicitation or offer to buy or sell the securities mentioned herein
Canadian Residents:
In respect of the distribution of this report in Canada, NBF accepts responsibility for its contents. To make further inquiry related to this report or effect any transaction, Canadian residentsshould contact their NBF Investment advisor.
U.S. Residents:
NBF Securities (USA) Corp., an affiliate of NBF, accepts responsibility for the contents of this report, subject to any terms set out above. Any U.S. person wishing to effect transactionsin any security discussed herein should do so only through NBF Securities (USA) Corp.
UK Residents:
In respect of the distribution of this report to UK residents, NBF has approved this financial promotion for the purposes of Section 21(1) of theFinancial Services and Markets Act 2000. NBF and/or its parent and/or any companies within or affiliates of the National Bank of Canada group and/or any of their directors, officers and employees may have or may have had interests or long or short positions in, and may at any time make purchases and/or sales as principal or agent, or may act or may have acted as market maker in the relevant securities or related financial instruments discussed in this report, or may act or have acted asinvestment and/or commercial banker with respect thereto. The value of investments can go down as well as up. Past performance will not necessarily be repeated in the future. The investments contained in this report are not available to privatecustomers. This report does not constitute or form part of any offer for sale or subscription of or solicitation of any offer to buy or subscribe for the securities described herein nor shall it or any part of it form the basis of or be relied on in connectionwith any contract or commitment whatsoever. This information is only for distribution to non-private customers in the United Kingdom within the meaning of the rules of the Regulated by the Financial Services Authority.
This report maynot be reproduced in whole or in part, or further distributed or published or referred to in any manner whatsoever, nor may the information, opinions or conclusions contained in it be referred to without in each case the prior express written consent of National Bank Financial.
Topic of the week
Unlike the United States, which went through ahousing crisis, Canada saw its residentialconstruction sector make a spectacular recovery.Indeed, construction employment is now only 3%shy of its 2008 peak and residential constructiontoday accounts for a very high proportion of theCanadian economy on a historical basis. What’smore, this proportion is presently greater than itsU.S. counterpart was even at the height of thehousing bubble south of the border. Based on theaverage annual household formation rate of 174Kfor the period from 2001 and 2006, the level ofhousing starts observed in Canada since the start of2010 might appear unsustainable. However,according to our estimates, the household formationrate should have accelerated since the last censusand should even have reached 212K in 2009.Moreover, we expect household formation toaverage 200K annually on a 5-year horizon. This isgood news for the residential construction sectorover the medium term. However despite floor-levelmortgage rates, the resale market is on the verge ofreverting to a buyer’s market, a situation that coulddrive housing starts to a level below demographicneeds in the short term. Given the normalization ofinterest rates under way, record-high home pricesand the end of a season of earlier-than-plannedhome purchases in Canada, we can indeed expectactivity to decline in the next 12 to 18 months.Fortunately, Canadian demographics remainsupportive for residential construction over themedium term.
Economic indicators review (p. 5)
Things to watch
Economic calendar and significant earningsannouncements of the week ahead (p. 6)
Economic tables (p. 7)
Residential construction in Canada:cyclical challenges, structurally sound
The residential construction sector recorded negative growthin the past three months, its first signs of losing steam sincethe start of this recovery.
The pullback comes on the heels of a strong rebound.Employment in construction is only 3% shy of its 2008 peakand the portion of the economy accounted for by residentialconstruction is very high on a historical basis. The situationin Canada is poles apart from the one in the United States,where the sector is still seeking to get over a housing crisis.
Since the beginning of the 2000s, the annual rate of housingstarts in Canada has averaged 201K. It is presently at 199Ksince the start of 2010. Such a level of activity might let usfear the worst insofar as, according to the latest availablecensus data, the annual average household formation rate inCanada stood at 174K from 2001 and 2006.
However, based on our forecast model, household formationshould have picked up sharply since 2006, peaking in 2009 at212K. From 2010 to 2015, household formation should recorda sustained annual average of 200K.
While demographics remain a positive factor for theresidential construction sector in Canada over the mediumterm, there are headwinds ahead in the short term. Despitefloor-level mortgage rates, the resale market is on the vergeof reverting to a buyer’s market, a situation that could meanseeing housing starts drop to a level below demographicneeds in the short term.
Solving an enigma
Since the beginning of the 2000s, the annual rate ofhousing starts in Canada has averaged 201K. As ithappens, based on the 2001 and 2006 census surveys,the annual household formation rate averaged only 174K.While several factors might explain a short-term gapbetween this demographic statistic and housing starts, thefact remains that the level of activity observed since 2006in Canada exceeds the formation of households from2001 to 2006, if we exclude the recent recession. Since2009, the rebound observed in construction and related
August 6, 20102employment has been impressive in Canada and standsin stark contrast with the situation south of the border. At atime when the resale market is softening and constructionactivity is beginning to flag, it is tempting to say that theheydays of residential real estate are gone, especially withinterest rates now normalizing. However, while a coolingperiod is surely to be expected in the short term, themedium-term outlook infuses us with a certain degree ofoptimism.
Construction losing steam
Since the recession trough, the construction sector hasgrown at a rate far above the average for the othersectors. Construction has been a key sector in the presentrecovery but it is now showing signs of losing steam, asevidenced by a negative 3-month growth rate (Chart 1).
NBFG Economy and Strategy Group (data via Global Insight)
1) Construction sector beginning to sag
Monthly GDP at factor costs 
3-month growth (%)
ConstructionTotal GDP
 If we break down the construction sector, we note that thesegment most affected over this period was residentialconstruction (Chart 2). Indeed, it is down 2.3% over threemonths while non-residential construction, instead, is up1.7%. Civil engineering construction, for its part, is downas well (-0.9%).
NBFG Economy and Strategy Group (data via Global Insight)
2) Sharper decline for residential sector
Monthly GDP at factor costs 
3-month growth (%)
ResidentialNon-residentialCivil engineering
 We must bear in mind that this decline comes on the heelsof a very impressive rebound in this sector. During the lastrecession, 30% of the 417K jobs lost occurred in theconstruction sector (Chart 3). Since that trough, 23% ofthe job gains have been in this sector. As a result,employment in construction is now only 3% shy of itshistorical peak.
NBFG Economy and Strategy Group (data via Global Insight)
3) Solid rebound in construction employment
Employment trend by sector since 2008 
SectorsJobs lost as %of total losses(417K)Jobs gained as% of total gains(403K)
Agriculture1%-5%Forest., fish. & trap., mining, oil & gas6%3%Utilities1%1%Construction30%23%Manufacturing50%-6%Trade5%17%Transportation13%-3%Finance, Insurance, Real estate-7%6%Health, education, pubblic admin.11%44%Other services-10%21%
*Because of rounding, totals may not add up to 100%
Poles apart from United States
Monetary easing by the Bank of Canada certainlycontributed to revive activity in residential real estate, as itdrove mortgage rates to historical lows. Instead, the Fed,which has had to deal with a housing crisis, has notmanaged to stimulate activity in the sector. As a result,over the past decade, while employment in construction isdown more than 15% in the United States, it is up morethan 50% in Canada (Chart 4).
NBFG Economy and Strategy Group (data via Global Insight)
4) Very distinct situations
Construction employment 
Index: 2000 = 100
United StatesCanada
 If we take a look at the portion of the economyrepresented by construction, the situations are markedlydifferent as well. Whereas construction accounts for lessthan 2.5% of the economy in the United States, itrepresents nearly 7% in Canada. What’s more, even atthe height of the U.S. housing bubble, the constructionsector in the United States just barely cleared 6%. It needbe said that, from a historical perspective, the Canadianeconomy has always had a proportionally larger
August 6, 20103construction segment. However, the gap with the UnitedStates has never been as wide as it is today. Does thismean that we should expect a reallocation of resources inthe Canadian economy, characterized by a contraction ofthe construction sector?
NBFG Economy and Strategy Group (data via Global Insight)
5) Very high proportion on historical basis
Residential construction as % of GDP 
3-month growth (%)
United StatesCanada
Housing starts in line with household formation?
 Well, as it turns out, actually, housing starts have recentlyclimbed back over the 200K mark on an annual basiswhereas the latest available data for Canada suggest thathousehold formation averaged 174K annually from 2001to 2006. In Chart 6, we can see that, historically, the levelof housing starts has been in line with the householdformation rate, although the former can diverge from thelatter for brief periods. What, then, explains these short-term gaps?
NBFG Economy and Strategy Group (data via Global Insight and CMHC)
6) Have housing starts outpaced household formationsince 2006?
Household formation and housing starts in Canada 
Household formationHousing starts
 Overall, the 1990s were a period when housing startslagged behind household formation. The opposite wastrue in the following decade. Part of the answer is to befound over by the resale market, the two markets beingcommunicating vessels (Chart 7). Indeed, the data showthat the ratio of new listings to sales was very high(surplus of homes for sale) in the 1990s whereas it wasvery low (shortage of homes for sale) in the 2000s, atleast until 2008.
NBFG Economy and Strategy Group (data via Global Insight)
7) Does imbalance in resale market explain gap?
Resale market and housing starts in Canada 
Ratio of new listingsto sales (L)Housingstarts (R)
No guarantee past will be repeated
As it happens, the ratio of new listings to sales indicatesthat the market has been balanced since the start of 2010but that it is now leaning towards a buyer’s market (Chart8). Under the circumstances, housing starts grazing the200K mark since the start of the year would appear to bedisproportionate relative to demographic needs asestimated on the basis of the 2001-2006 period.
Buyer’s market Seller’s market 
Ratio of new listings to sales
SalesNew listings
Balanced market 
NBFG Economy and Strategy Group (data via CREA)
8) Headed for buyer’s market?
Resale market 
 In order to gain a better idea of the situation regardinghousehold formation since 2006 and to make projectionsthrough 2015, we applied the rates of householdmaintainers by age group from the 2006 census toStatistics Canada’s population projections by cohort(demographic assumptions for 2006-2008). The results ofour estimates are very interesting. They indicate that theannual household formation rate should be up sharplyrelative to the average for 2001-2006 and would havepeaked in 2009 at over 212K (Chart 9). Furthermore, theprojected average for the period from 2010 to 2015 isestimated at 200K, which doubtless constitutes good newsfor activity in the construction sector over the mediumterm.

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