Bank of Canada lays out possible housing downturn scenario

The country’s central bank is still nervous about Toronto’s overbuilt condo market.

Citing a glut in new units in the country’s biggest city as a primary concern, the Bank of Canada warned again Tuesday that Canada’s housing market and the broader economy remain exposed to an “elevated” risk of a slide.

While the bank continues to see a soft landing for the housing market, its latest report on potential threats to the country’s financial system details how a correction might unfold. And it isn’t pretty.

The number of pre-construction condos set to be built in greater Toronto – an indication of future supply over the next few years – has declined from the city’s peak in 2011, the bank says, but the net number of unsold units remains high.

According to estimates, 20,000 new units are expected to come onto the market next year, a figure well above what demand normally supports, according to a report last week from Royal LePage.

Condo prices in Toronto are already flattening, the bank said (see chart), while the supply of new units could pressure outright declines. If condos don’t find buyers at a brisk enough pace, new projects will also face delays costing construction jobs –  a major provider of employment in the greater Toronto area in recent years, the bank said.

“If the upcoming supply of units is not absorbed by demand as units are completed over the next few years, there is a risk of a correction in prices and construction activity.”

Things then start to look not so good for the rest of Toronto’s housing market, where prices have soared well above income growth over the past decade as ultra low interest rates that have spurred borrowers to take on larger home loans.

“A sharp correction in the condominium market could spread to other segments of the housing market with stretched valuations, as buyers and sellers adjust their expectations of the future path of house prices,” the bank said.

“Such a correction could also have significant repercussions on the real economy, since the construction sector is an important component of economic activity,” the bank said.

A slowdown in the GTA threatens to ripple into other markets in two ways, the bank said. First, through sapping confidence among buyers and sellers witnessing developments in Toronto; second, tighter lending elsewhere.

A chill could set in across much of the economy, the report said.

“Such an occurrence would generate widespread reductions in household net worth, market confidence and consumer demand, with negative spillover effects on income and employment.”

Smaller lenders and investors such as credit unions and private equity funds would be most at risk, the bank said. The loan books of the big banks and mortgage lenders would also be affected, though.

READ MORE: Paying for the boom — a look at home price growth by neighbourhood across major Canadian markets 

The Bank of Canada’s updated view largely reiterates concerns set out in June, the last time it delivered a report on the state of the Canadian financial system.

Since, Toronto’s condo market has cooled but the broader housing market has shown renewed strength.

Experts like economists from TD Bank and Royal LePage contend that echo boomers who are unable to afford a single family home in Toronto but are unwilling to buy far afield in the suburbs will mop up the excess supply of condominiums.

Ontario’s economy is also expected to improve over the next couple of years, adding as many as 300,000 jobs. The unemployment rate is expected to drop to 6.3 per cent, according the Conference Board of Canada.

Underlying the gloomy worst-case scenario is the record amount of debt Canadian households have accumulated in recent years, exposing them to economic “shocks” they might otherwise have been able to absorb, the bank and others say.

The central bank report said that despite a resurgence in borrowing among households this year, is expects debt levels to resume “moderating” and the above risks to “diminish over time.”

That idea will be tested later this week when Statistics Canada publishes its updated glimpse into borrowing habits between July and the end of September.