Outlook 2005

It's still a seller's market.

Canada's housing market hit several milestones in 2004. Existing home sales broke records across the nation, average resale prices rose at the fastest pace in over a decade, and housing starts reached a 17-year high. Anyone looking for a contractor will attest to the boom in new construction and renovation activity. And just try to find a weekend parking space at those proliferating home-improvement stores.

Housing will likely remain an important contributor to the Canadian economy in 2005, though the pace of activity is bound to cool. Market conditions are becoming more balanced as the supply of new listings catches up to sales. Pent-up housing demand is on the wane, especially among potential first-time buyers, who drove much of the market's ascent in recent years. By and large, this is still a seller's market. But expect fewer bidding wars for properties, more days on the market and slower price appreciation.

Housing affordability should remain fairly good, though the best news is in the past, with mortgage rates at risk of moving higher. If longer-term rates were to increase one percentage point, it would add about $100 to the typical monthly mortgage payment on a new purchase. At the margin, this could push potential buyers out of the market. A greater risk appears to be a further softening in employment conditions, as export-sensitive businesses adjust to the realities of a stronger Canadian dollar.

At the same time, rising apartment vacancy rates are improving the attractiveness of renting over buying. The influx of first-time home buyers into the housing market, combined with a rise in the supply of rental units after an extended drought, has led to a more than doubling in nationwide vacancy rates over the past three years. This in turn is putting downward pressure on rents. Vacancy rates will likely edge even higher in 2005, with the boom in condo development in most major urban centres bringing additional investor-owned rental units onto market.

Yet the odds of a major correction in housing markets are low. The inventory of completed but unsold new homes remains relatively moderate, at just over half the level of 1990. The geographical diversity of the current housing boom is also not indicative of a seriously overheated market or of overly speculative investor activity. While there will always be “hot pockets” of activity, the strength in housing markets in recent years has not been isolated to one or two major centres, or even to large urban areas. Rather, it would appear households across Canada have responded to low mortgage rates, strong employment gains and affordability.

Moreover, home ownership continues to be seen as a good long-term investment, especially in light of paltry stock market gains and low nominal returns on interest-bearing assets in recent years. Indeed, real estate assets have become an increasingly important component of household wealth and savings. Even so, the typical Canadian homeowner is not unduly exposed, as home values have been rising faster than mortgage borrowing. And thanks to ultra-low interest rates, mortgage servicing burdens are at historically low levels.

On a regional basis, the hottest housing markets in 2005 will likely be in the West, supported by oil and gas investment, high interprovincial migration, and close trade ties to fast-growing Asian nations. For Central Canada, strong immigration will remain an important factor underpinning housing demand, but cost-cutting efforts by manufacturers point to softer employment conditions. Less favourable demographics and weak tourism suggest housing markets in Atlantic Canada will also be less buoyant than those in the West.

Adrienne Warren is a senior economist and manager with Scotiabank in Toronto.