The story highlights the challenges in Canada’s housing sector. While the country’s economy is slowing down, the housing market is contracting at an even faster pace. Residential investment has dropped to 6.1% of GDP in Q2 2023, a significant decline from the previous year. This rapid decrease, the sharpest since 2001, raises concerns reminiscent of the late 1980s housing bubble. Stimulative population policies are preventing a complete collapse, but a painful adjustment is looming. Canada’s housing investment remains high compared to its trade partners, like the US at 4.6% of GDP, but the need for a rebalancing of capital allocation is evident.
Canada’s economy has historically thrived on the housing sector, but it appears that this sector may have reached its growth limit. In the second quarter of 2023, residential investment, which directly contributes to GDP, experienced a decline. In just two years, residential investment went from representing nearly 1 in every 11 dollars of GDP to the smallest proportion seen in over two decades.
Residential investment encompasses activities such as constructing new homes, significant renovations, and expenses related to property ownership transfers. However, it's worth noting that while this measure captures a significant portion of housing’s impact on the economy, it doesn’t provide a complete picture. For instance, the banking and insurance sectors in Canada are closely connected to housing but are classified separately.
The contribution of residential investment to an economy is a finely balanced aspect that plays a crucial role in its overall health. Housing is an essential aspect of any society, and as an economy expands, its investment in housing should naturally increase. The concern arises when this housing investment grows faster than the overall economic growth, leading to a larger portion of it in the GDP. When housing investment becomes a substantial proportion of GDP, it signals a misallocation of both human and financial resources. Such economies prioritize accommodating people rather than focusing on their productive activities. This situation amplifies the risk, making economic downturns more severe than necessary.
Conversely, insufficient residential investment can indicate another set of issues. People tend to allocate funds to housing when they are confident enough to borrow money. Borrowing confidence is closely tied to their trust in the economy and job security. A decline in housing investment often serves as an early indicator that households are losing confidence in these aspects, typically occurring just before a recession sets in.
To provide some historical context, during the peak of the US housing bubble in 2006, residential investment in the United States surged to an alarming 7% of GDP. Experts sounded the alarm, noting that this was an unsustainably high proportion of the economy, and their concerns were justified. As this share of residential investment corrected to a more typical range of 3-4%, it necessitated a reallocation of both human and financial resources. This adjustment resulted in substantial job losses and financial setbacks, so significant that their impact rippled through the global economy.
Similarly, the Canadian housing market is now readjusting to more sustainable levels after reaching unsustainable highs. In the second quarter of 2023, residential investment in Canada experienced a 2.0% decline, amounting to $133.1 billion, marking a notable 13.8% decrease compared to the previous year. Although this is a significant drop, it’s important to note that housing investment remains substantial. The dollar volume is comparable to levels seen prior to 2020, a period during which Canada was already recognized as having a considerable emphasis on its housing sector
Canada’s overall economic performance is showing signs of deceleration, but the housing sector is experiencing a more pronounced contraction. In the second quarter of 2023, residential investment declined by 0.1 percentage points, accounting for 6.1% of GDP. This marks a decrease of one percentage point compared to the same quarter in the previous year. To truly grasp the speed of this decline, it’s essential to consider it in a broader temporal context.
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