By Ted McIntyre

Price rise expect to slow, but other factors confound the economic experts

Inflation. Rising interest rates. A trades shortage. Housing supply. A looming provincial election. Supply-chain delays and subsequent material shortages and cost increases. 

There’s a barrelful of wrenches that have been tossed into the 2022 economic machine. And then there are the intangibles, such as rising tensions surrounding China and Omicron (or the next COVID-19 variant that comes along).

While a miniscule Bank of Canada rate (it was 0.25% as of mid-December) and correspondingly favourable mortgage rates have obviously fuelled the current environment of record-high housing prices, momentum is expected to slow, says Bob Dugan, Chief Economist with the Canadian Mortgage and Housing Corporation (CMHC). 

One contributing factor will be the Bank of Canada’s ending of its quantitative-easing program last October. Under the program, the feds purchased loads of government bonds to increase their price, subsequently driving down interest rates and promoting borrowing and spending in the economy. But with its conclusion, rates can be expected to “push up in the long end of the curve,” Dugan says. 

After a white-hot 2021, Dugan and the CMHC are forecasting a comparatively modest 5% increase in housing pricing this year, with two elements combining to bring about a better balance between supply and demand.

“During the pandemic we saw some one-off drivers of demand—things like people leaving large urban centres to live in suburban or rural communities and secondary Canadian metropolitan areas such as Kingston, Barrie and Ottawa, because they no longer have to commute every day. There was also a shift in demand toward lower-density housing with more space so they can set up a home office. But as we look ahead, that’s unlikely to continue. 

“The other thing we think might put the brakes on activity is a rise in mortgage rates going forward—more so than previously anticipated because of inflation issues,” Dugan adds. “But now, how does the Omicron variant change the outlook for the economy, and  what does that mean for the Bank and inflation? I haven’t quite worked that out yet.” 

When it comes to supply, Douglas Porter, BMO Financial Group’s Chief Economist and Managing Director, applauds builders for “really responding in a huge way” last year. “I think we’ll find that housing starts for 2021 were (the second-highest) we’ve ever seen,” Porter predicts. “In the past 12 months, they’ve been running at more than 270,000 units. There’s been one time in recorded history where Canada has had higher housing starts over a 12-month period—­1976, when the first wave of baby boomers entered the job market.

“The fact is that demand for housing is torrential, whether it’s from investors, immigration, population growth or millennials. Supply is strong; it’s just struggling to keep up with the tidal wave of demand.”

CMHC is predicting 81,100 new home starts in Toronto in 2022, outnumbering last year’s total of 77,210. However, housing starts for much of the rest of Ontario are projected to decrease this year, with only Hamilton and Ottawa also looking to top 2021 numbers. 

The Ontario RE/MAX broker network is forecasting “average price growth” in its 2022 Canadian Housing Market Outlook Report. Numbers in small markets vary widely, though: North Bay (4%), Sudbury (5%), Thunder Bay (10%), Collingwood/Georgian Bay (10%) and Muskoka (20%).

“Meanwhile, in larger markets, there’s a possibility that more immigration could weigh on supply levels and prices, including Ottawa (5%); Durham (7%); Brampton (8%); Toronto (10%) and Mississauga (14%).”

Rising Costs

For builders trying to meet that demand, back-end costs are showing no signs of easing. Apart from supply-chain-fuelled increases for material costs, the trades shortage is only worsening, driving up labour costs and delays. And with intensification, land prices are also marching forward.

As for materials, there might never be a return to pre-pandemic prices, says Edward Jegg, Altus Group Analytics Team leader. “Lumber was an extraordinary one and we’ve seen it come back from triple-digit increases down to double-digit. Will it ever go back? When things go up, do they ever truly come all the way back down?”

“It’s a fact that lumber is never going back to $400 US (MBF/1,000 board feet) like it was for 10 years up to 2019. And prices are definitely going to go up,” says Kéta Kosman, publisher of Madison’s Lumber Reporter, the bible of lumber industry analysis in Canada.

“One of the ways we know that prices will stay up is how far ahead sawmills are on the production they book,” Kosman explains. “Traditionally this is not a time of year when building is strong. Order files are usually a few days out or even ‘prompt,’ when you can call the sawmill in the morning and they’ll put wood into production that day. But now order files are booking into the next month! If I’m a home builder and I have projects planned for the next (few months), I would not wait to buy.”

 Apart from new housing starts, the market is also being affected by an increase in extreme weather events, Kosman notes. “They’re having to rebuild parts of Kentucky (tornado) and B.C. (flooding). And even if you’re not building with wood, you still need wood for things like concrete forming and scaffolding. When New Orleans was rebuilding in 2005 and was declared an emergency, FEMA bought huge volumes of wood and didn’t care what the price was. In most weather events, like a hurricane, you don’t see an immediate increase in (wood) buying since insurance papers need to go through. But when the government gets involved, it’s a different story.” 

Rising Rates

While lumber outlets and other suppliers are building higher expenses into product costs, price gouging isn’t occurring, Jegg contends. “If you’re a supplier, you’re just trying to get your stuff out to anybody.”

Inflation, however, is a concern. The Consumer Price Index was 4.7% in November, remaining at its 18-year high recorded the previous month. South of the border, the U.S, was recording 6.8%—a 40-year high. Both Dugan and Porter say that it’s inevitable that interest rates will be raised to help nip inflation in the bud.

“The landscape has gotten a little muddier with this new (pandemic) variant,” Porter says. “But while financial markets are taking a bit more of a cautious stand, there’s still the overwhelming view that the Bank of Canada and the U.S. Federal Reserve will be raising rates this year. I think it’s reasonable to look for two to three rate hikes of a quarter-point each. Financial markets think the Bank of Canada will hike rates by more than a full point, but I see that as a bit aggressive.”

CMHC’s Dugan reminds that as inflation impacts other goods and services, it “erodes real incomes,” making it problematic for potential homeowners to save and invest in real estate. And the squeeze is about to get tighter for the lower and middle classes, who will most feel the effects of the anticipated 5%-7% hike in food prices this year, adding almost $1,000 to the annual grocery bill for the average family of four, according to the latest Canada’s Food Price Report.

The economy is experiencing a pandemic-driven “supply shock,” explains Dugan. “A year ago, following the start of the pandemic, oil prices and food prices were lower, and we’ve seen increases since,” he notes. “As the economy starts to grow again, these base effects were supposed to have a very temporary impact on inflation. But inflation is proving to be more resilient than originally thought, creating more sustained upward pressure on prices.”

Dugan believes the Bank of Canada will target 2% inflation. “Gradually, interest rates will have to come up to get inflation back in line,” he says. “As that unfolds, that can raise some of the financing costs, further adding to the difficulty of people to save for a down payment.”

“Between the kind of bidding wars and the price gains we’ve seen, not to mention the kind of down payment now required, this is one of the more challenging environments that we’ve ever seen for entry-level buyers,” says BMO’s Porter. “The flipside is that jobs are still relatively plentiful. Incomes have been very well supported in the past year and there’s a tremendous amount of wealth out there. Now, whether that wealth is in the hands of first-time buyers is debatable or doubtful.”

Dugan is also concerned about the reality of homeownership for many. “We need to find a way to stabilize high prices so that we don’t have further erosion in affordability. Then, over time, incomes can catch up and narrow that gap.”

One simple solution is to increase supply,” Dugan offers. “We’ve seen what demand can do to house prices during the pandemic, so we absolutely need a supply response in order to help improve affordability—and on the rental side too.

“There’s also a need for strong levels of housing starts because as international borders open again, the Canadian government has aggressive targets for immigration,” Dugan says. “If we’re going to try to attract 400,000+ immigrants to Canada after the pandemic, they’re going to require housing.”

Ontario alone will require one million new homes in the next 10 years, according to research from Mike Moffatt, Senior Director, Policy and Innovation, at the Smart Prosperity Institute.

But additional supply must also be done in a targeted way, Dugan stresses. “We have to build more affordable homes—maybe higher-density homes suitable for young families. A lot of condos (right now) are one-bedroom or bachelor suites that aren’t suitable for families.”

If there is good news to be had, it’s that neither Dugan nor Porter expect a recession in the foreseeable future.

“And there are some positive developments,” Dugan contends. “The labour market is improving. Canadian households have been saving money. The savings rate going into the pandemic was about 2%, but it was about 11% in the third quarter of 2021! The problem is that those savings aren’t equally distributed across households. The higher-income households are saving money and some of the lower income households that are either renting or are trying to save to buy a house are probably not.

“However, those savings do provide some upside for the economy,” Dugan continues. “At some point when we’re able to travel again more readily or when more people feel comfortable going out shopping and to restaurants, there’s an awful lot of savings out there that can stimulate spending and create growth.

“Our own forecast is that economic growth will continue next year at about 5.5% in 2022,” Dugan says, “although that may be a little optimistic.” 

For its part, RBC’s Provincial Outlook, released in December, “projects economic growth to clock in at 4.4%, unchanged from 2021 (4.4%) and ranking as the fastest rate east of the Prairies.”

Nationally, the economy has more than overcome its early pandemic losses, notes Colliers, a leading commercial real estate services and investment management company. In its 2022 Canada Outlook, Colliers cited that the country’s gross domestic product was expected to surpass pre-pandemic output before the end of 2021. And “as for the almost 3 million jobs lost at the beginning of the pandemic, Canada officially recouped these jobs and surpassed the pre-pandemic peak in September of 2021.”

Growing Gap

But the issue of affordability remains. As a point of comparison, in 1985, the average price of a Toronto home was $109,094. As of December it had soared to $1,163,323, a 22% jump from 2020 and a whopping 966% leap from 1985.

The median family income in 1985 in the city, meanwhile, was $31,965. Today it’s $86,875 according to CMHC. That’s a 172% jump. In other words, the percentage increase in home prices has outpaced income by more than five and a half times. 

That gap will inch a little wider in 2022, Dugan says. “As we look ahead, even if (home) price growth slows to something like 5-6% in 2022, that’s still faster than the typical income growth will be.”

But demand from beyond our borders will likely pick up the slack. According to a 2021 report on global talent from Boston Consulting Group and The Network, who surveyed 209,000 people in 190 countries, Canada has overtaken the U.S. as the most attractive destination for foreign workers.

And as political and social turmoil increases around the globe, the attraction of Canada, with its increasingly attractive freshwater reserves, healthcare and social reputation, only grows. 

The moving parts of the economy remain and will provide no shortage of challenges, but the Jenga pieces assembled at this stage for the home building industry resemble much less a teetering tower than they do a sturdy brick fortress.

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