Canada's Non-Stop Housing Boom

Summary

• June's housing builds rise as interest rates increase in July.
• People will have to finance new homes at higher borrowing rates.
• Government policy and market sentiment are out of line.

Canada's market has shown through June's economic data, the number of houses being built on an uptrend. Courtesy of the CMHC, 215,459 housing starts tallied for the previous month accompanied by the announcement to raise interest rates. Housing sales have been falling in markets such as Toronto, but construction has continued significantly. The increasing amount of homes being built should send some worries and could create multiple issues. Coupled with interest rate increases will make mortgages more expensive through higher borrowing costs, and housing particularly is a debt-based asset (home prices rise despite rate hike). Purchasers will be looking at paying higher prices because of borrowing costs for these newly built homes. Housing construction is essentially speculating that these homes can be purchased by individuals who are either from buying overseas (implications of foreign buyers) and people who seek to purchase a new or first home, mainly through financing. Capital gains increase on real estate is quite present and it further initiates the borrower to have to finance a longer sum and increasing rates has borrowers worried. The notion construction booming is great for builders through financing projects and selling them off at the high market prices, this could fuel potential excess supply if the demand sentiment changes (speculative euphoria), and market prices decline.

The construction boom is lucrative for financiers of real estate development during high market prices ensuring increased profits. Similarly, people look to renovate their current real-estate if they know the investment adds equity to their house. The short-sightedness of construction focuses on the prices now and not other future factors. If home prices decrease the new renovation may not have been worthwhile, mortgages if too large could render negative equity and the new amount developed could become excess supply. Also, if interest rates continue to increase further it will bring about questions regarding the sustainability of mortgage repayment.

Canada, especially the real estate sector has always been a relatively safe investment for foreign investors due to strong Canadian regulations and government stability. The importance of knowing the state of Canada's housing boom for American and domestic investors is crucial. By ignoring the risks associated with increased construction (supply) and mortgages (debt), any sudden expected shocks would hurt mortgage financiers and construction financiers. Further, it could even cause excess supply and drop the prices drastically. Canada's policy makers are currently walking a thin line trying to find the balance to cool the market and avoid crashing the market. The government implemented fiscal and monetary policies are being put in place to try to cool down the booming markets. For Vancouver, a 15% foreign buyers tax introduced in 2016 sought to offset the rapid valuation increases. More recently in Toronto, their own version of the foreign buyers' tax plus other cautionary measures were recently introduced to offset the exponential price growth. Even the Bank of Canada (BOC) has acknowledged that low-interest rates have played a part in the housing boom. Although there are other economic factors that go into the decision to raise interest rates, there is pressure on the BOC to raise interest rates as soon as possible in order to help control the market. The housing market has politicians worried as they try to enact policies that deter rapid growth, but it seems as prices grow so does supply as continuous strong housing starts are present (Canadian Housing Starts Data).

Any outsiders to the Canadian market should understand the domestic risks, as any downturn would affect your equities located on Canadian exchanges. The housing risks would contribute towards other parts of economic activity declining and if a downturn occurs too quickly or if any negative economic indicators become present, measures should be taken as an investor to move away from Canada's potential risk. It is further necessary to be aware of the market risks when analyzing companies facilitating business in Canadian real-estate financing (even banks), construction, and materials.

Analyst’s Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.