Positive Economic Fundamentals
By Dr. Peter Andersen

Economic fundamentals should support housing and renovation demand through the rest of this year. Forecasts for GDP growth are now being revised upward in response to unexpected strength in consumer demand.
Canadians are currently enthusiastic big-ticket discretionary spenders. They are showing an increased willingness to take on more debt in order to finance purchases. Outside of Ontario, they are also optimistic about the prospects for short-term job growth. Confidence has soared in the Prairies and British Columbia.
Motor vehicle purchases have rebounded from last year's slump. This shows positive consumer attitudes and a willingness to commit to large purchases. It is a good indicator for both housing and renovation demand.

Mortgage rates have declined
Bond yields and mortgage rates have defied earlier consensus forecasts, which have repeatedly warned of higher rates. This is a major reason for the current strength in housing demand. In the U.S., the benchmark 10-year U.S. Treasury yield has again dipped below the 4.00 per cent level despite the Fed's policy of "measured" short-term rate increases. This has set the trend for mortgage rates on both sides of the border.
The declines in long-term rates, combined with increasing short-term U.S. rates, are producing a flatter yield curve. Fears that this is a recession signal are unwarranted. First, the spread between long-term rates and short-term rates is not out of line with the experience during the business expansion through the second half of the 1990's. In addition, the flattening in the yield curve is actually the result of positive underlying developments.
It reflects the fact that corporations are flush with cash. Profits are running at record levels both in absolute terms and relative to GDP. As a result, corporations are able to finance capital expenditures internally without the help of the debt markets. Interest rates are determined by demand and supply and currently there is very little external demand for business financing.
The conventional fixed 30-year rate in the U.S. is now approaching the 5.50 per cent level and the lowest transaction rate (as opposed to the quoted or board rate) on five-year mortgages in Canada is down to 4.50 per cent. The one-year variable mortgage rate in Canada is running at 3.75 per cent. These are exceptionally low rates and the end result is a powerful incentive for prospective new home buyers.

Still a sellers' market
The resale market sets the tone for the new housing market and also renovation. The spring selling season for Canada's new home builders and renovators was given a strong boost by the continuing sellers' market for existing homes.
Resale activity was brisk this spring, with transactions running at close to a record pace. Unit sales increased in both April and May, after accounting for seasonality. So far this year, the hot markets have been Victoria, Calgary, Edmonton and Montreal.
Also new records for May were set in Saskatoon, Vancouver, Calgary, Winnipeg, Montreal, Quebec City and St. John's. Through the first five months of 2005, unit sales were basically running even with the same period a year earlier. This is a remarkable achievement as 2004 was an all-time record year for the resale market. The average January to May resale price was up by eight per cent, year over year.

Housing starts
Housing starts have trended downward through the first half of this year. For the first five months of 2005, starts were 7.0 per cent lower than in the same period a year earlier. Year-to-date single starts are down by 10.4 per cent and multiple starts by 3.5 per cent.
However, this does not mean that Canada's housing cycle is over. We are still forecasting that housing start activity in Canada will remain at a relatively high level through to the end of 2006, supported by a respectable economic outlook, exceptionally low interest rates and positive demographics.
We should remember that Canada's housing cycle is still relatively young. It really only began in 2002. In contrast, the U.S. cycle began in the mid-1990's and is now in its later stages. Our forecast of 215,000 housing starts in 2005 and 205,000 in 2006 compares very well with the experience of the last 30 years.

Immigration
The inflow of international immigration into Canada has recently picked up. The latest figures show immigration running at 239,000 per year with 54 per cent coming to Ontario. This is keeping Canada's population relatively young and is generating healthy population growth. Canada's working-age population is increasing at a hefty 1.4 per cent annual rate.
Canada has the youngest and the fastest growing population of all the major industrialized countries. Canada's immigrants place a high priority on homeownership. In the short-term they are producing a supply of tenants for the rental market. By having a relatively robust demographic profile in its younger generations, Canada can sustain high levels of housing activity for a number of years.

Renovation
If one includes repair and conversions, Canada's residential renovation market is now larger than the new housing market - in excess of $40 billion. The major alterations and improvements component is on a prolonged and sharp upward trend. It increased by 13.6 per cent in 2004 and now stands at $29 billion.
The latest figures for the first quarter of 2005 show it increasing at a 10.6 per cent year-over-year rate. Renovation has now replaced new construction as the growth sector in Canada's housing industry.
This growth momentum has continued this spring, as indicated by retail sales for home centres and hardware stores and also by wholesale sales for building supplies. The former shows a 13 per cent yr/yr increase in April and the latter, a 10 per cent increase. Retail sales of building and outdoor home supplies, which are a proxy for do-it-yourself renovation spending, showed the largest sales growth of any retail sector in 2004 and continued to be the retail growth leader this spring. Sales of building supplies have been particularly strong in Alberta.

Risks to the Housing Outlook
Another spike in the world oil price would be bad news for Canada's new home builders and renovators. The U.S. economy has survived the first oil price shock but if the benchmark oil price were to jump again to the $65-70 per barrel range, a 2006 U.S. recession could occur. There is a vulnerability to such an event late this year, heading into the winter heating season. Canadians do not live in a goldfish bowl. A recession in our most important trading partner would inevitably flow over into Canada, despite our position as a net exporter of hydrocarbon energy.
A companion risk is the exposure of the high-rise multiple unit sector to an adverse change in market conditions. The inventory of newly completed but unoccupied row, apartment and condo product is up sharply - a 60 per cent yr/yr April increase. HB