Life after oil makes real estate the new crutch of Canada’s economy — and it’s huge

Erik Hertzberg and Theophilos Argitis, Bloomberg News

Two things happened last week that were a reminder of just how vital real estate has become to Canada’s economy.

On Friday, Statistics Canada released gross domestic product data that showed February was a banner month for sectors linked to housing. The real estate industry, residential construction, financial and legal services generated a combined 0.5 per cent increase in output, the biggest one-month gain since 2014. Without those, the overall economy would have contracted slightly in February.

A day earlier, the Ontario government released a budget that projects land transfer taxes will surpass $3 billion in the current fiscal year, from $1.8 billion three years ago. For the province, it’s the difference between a balanced budget and a deficit.

Measures of housing’s contribution to the economy are imprecise, but estimates largely put the direct contribution in excess of 20 per cent.

It’s much more than that once you add all the indirect effects, with benefits spread widely from lawyer fees to government revenue and increased retail purchases through so-called wealth effects as rising home equity values prompt households to ramp up consumption. The big worry is that Canada has moved from a reliance on oil to a reliance on real estate.

“You don’t need a collapse in house prices, you don’t need housing starts to be cut in half for weaker real estate sector to have a significant effect on GDP and incomes,” Chandler said. RBC’s ballpark estimate is that a 10 per cent decline in national home prices would knock a full percentage point off growth.

A Toronto Dominion Bank report from 2015 found the housing wealth effect has been responsible for about one-fifth of all growth in consumption since 2001.

“A lot of the strength we have seen in consumption is housing related,” said Brian DePratto, the economist who wrote the 2015 report. If you strip out the direct and indirect impact from housing on the economy, “you are talking about a much lower trend pace of growth.”

Record Loans

It’s hard to believe, but there was a time not long ago when Canada’s banks lent more to businesses than home owners. It was the norm in fact until the early-1990s, when mortgage loans surpassed business lending for the first time. Residential mortgages today make up about 52 per cent of all chartered bank loans, versus 21 per cent for business lending.

The last time the inflation gap between Toronto and the rest of the country was this wide was in the late 1980s, during the last housing bubble

Still, that portion of business lending is up from a record low of 19 per cent in 2012, suggesting that as home valuations become stretched and as mortgage and capital regulations tighten, banks are increasingly looking to companies for lending growth.

A closer look, however, reveals that much of the new business lending is in fact real estate related. Bank of Canada figures show 14 per cent of all private business loans from chartered banks are now bound for so-called real estate operator industries, the biggest share in the history of data back to 1981.

The $27.4 billion in private loans to the sector, which represents companies that own and manage real estate assets, exceeds the combined lending to the manufacturing and oil and gas sectors combined. That’s on top of the $15 billion loaned to developers, more than double levels in 2010.

The chartered banks are also lending to real estate operators at the fastest rate on record — $10 billion since the start of 2014.

The pattern makes sense. Profit margins in real estate rental, leasing, and property management industries were around 34 per cent in 2015, Statistics Canada data show, and banks want to lend to profitable businesses. Yet, it also means lenders are increasingly exposed to the industry on multiple fronts.

Week Ahead

• MLI Leading indicator (Monday, 7 a.m.)
• GDP by province (Monday, 8:30 a.m.)
• Markit Canada manufacturing PMI (Monday, 9:30 a.m.)
• Bloomberg Nanos consumer confidence index (Monday, 10 a.m.)
• Census data on age, sex and type of dwelling (Wednesday, 8:30 a.m.) I
• nternational merchandise trade (Thursday, 8:30 a.m.)
• Jobs, principal field crops (Friday, 8:30 a.m.)
• Also: Desrosiers light vehicle sales, Vancouver and Toronto home sales

Mind the Spread

Home arbitrage opportunities are dwindling in the Greater Toronto Area, where benchmark prices are accelerating in suburbs within commuting distance of the downtown core. The spread between the price of benchmark homes in the bedroom communities of Oakville-Milton versus Toronto has disappeared in the last six months. That may help explain the recent run-up in prices in Toronto. The inability for residents to cash-out at the higher prices may be influencing the dearth of new listings in the area, further stoking price gains.

Toronto Inflation

Another consequence of the housing boom is that inflation has been stronger in Toronto than in the rest of the country. Over the past three years, annual monthly inflation has averaged 1.9 per cent in the country’s largest city, about half a percentage point higher than the national rate.

The last time the inflation gap between Toronto and the rest of the country was this wide was in the late 1980s, during the last housing bubble.

After the market crashed in 1989, inflation in Toronto lagged behind the rest of the country for four straight years.
Bloomberg.com