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Bank of Canada Issues Harsh Warning on Condo Market

Bank of Canada warns on condos
The Bank of Canada issued a harsh warning today about overbuilding of high-rise housing, notably condos.

“In the current context, a specific concern is that the total number of housing units under construction has been increasing and is now well above its historical average relative to the population,” the central bank said in its financial system review.

“This development is entirely accounted for by multiple-unit dwellings (which include condominium units), especially in major metropolitan areas.”

As Canada’s housing market cools, the condo sector has been of particular concern, notably in Toronto and Vancouver. Sales in both cities are down sharply after the federal government moved again in July to cool things down.

Canadian policy makers have been concerned over both the housing market and the record debt burdens among households, the central bank said earlier this week that credit growth has at least been slowing.

Today, as The Globe and Mail’s Barrie McKenna reports, the Bank of Canada again voiced in concern over the vulnerability of consumers to “economic shocks,” such as a housing bust or a spike in unemployment.

That doesn’t mean observers expect either, only that the central bank is concerned.

Today, it took a deeper look at the housing market, and at condos in particular, noting the rapid pace of construction and warning about speculative demand.

“If investor demand has helped spur levels of construction in the condominium market that are above those consistent with demographics, this market will be more susceptible to changes in buyer sentiment,” it said.

“If the upcoming supply of units is not absorbed by demand as they are completed over the next 18 to 36 months, the supply-demand imbalance will become more pronounced, increasing the risk of a sudden correction in prices”

That, in turn, could pressure house prices in general, which itself would spread through the broader economy.

“This would likely lead to a decline in housing activity, adversely affecting household incomes and employment, as well as confidence and household net worth, which would in turn reduce household spending,” the Bank of Canada said.

“As the declines in incomes and employment impair households’ ability to service their debt, loan losses at financial institutions would likely rise. These effects may be amplified by tighter borrowing conditions as lenders come under increased stress. These interrelated factors would further dampen economic activity and add to the strains on household and bank balance sheets. They may also cause house prices to fall below the level required to correct any initial overvaluation.”

The Bank of Canada has warned about this before. And where Toronto is concerned, there was a particular focus.

It cited the rise in the number of unsold units – to 14,000 from 7,000 since June 2011 where preconstruction is concerned, and to some 7,000 from less than 5,000 at the beginning of the year of those under construction – as sales drop and prices flat-line.

“This suggests that demand is slowing at a time when the potential supply of unsold units (including those in preconstruction) is still strong,” the central bank said.

“Discussions with developers indicate that they are seeking to mitigate the risk of overbuilding by phasing projects and adjusting new supply to reflect the evolution of demand. Delays (or cancellations) of projects, however, can be costly.”

It noted that developers are liable for up to $7,500 in expenses  because of delays, beyond scheduled occupancy, after a contract is signed in Ontario.

The Bank of Canada also cited the fact that the size of condo units has been shrinking for the past couple of years.

Anecdotal evidence suggests that’s what investors want but “greater involvement by investors could potentially increase the volatility of housing prices and sales, under stressed conditions.”

The central bank also repeated its warning that the biggest domestic threat to financial stability “continues to stem from the elevated level of household indebtedness and stretched valuations in some segments of the housing market.”