08/09/2011 09:41 EDT | Updated 10/09/2011 05:12 EDT

Canada Housing Starts Post Unexpected Jump In July


A stronger than expected housing market has helped propel growth in the Canadian economy this year, but economists say recent economic and market tumult could jeopardize momentum in the sector.

The Canada Mortgage and Housing Corp. said Monday that national housing starts rose to 205,100 units on a seasonally adjusted basis in July, 11.6 per cent higher than the 188,900 reported in the same month last year and 4.3 per cent more than the 196,600 recorded this June.

However, the pickup, driven by strong construction on condos and apartment buildings in urban centres, is likely due to builders catching up to robust demand last year, rather than expectations of coming growth.

Home building activity has been increasing through the first seven months of 2011, but starts are still down 4.6 per cent from a year ago.

During the first half of last year, the market was rebounding from recession and buyers were on a tear, prompting an influx of demand and the need to build more units.

Housing starts tend to lag activity in the resale market, and economists believe the recent strong construction activity is the result of increased demand last year.

But they doubt whether the pace can continue as the prospect of a double dip recession in the U.S. forces them to rethink the prospects for economic growth in Canada.

The housing market and the Canadian economy as a whole are more susceptible to an economic downturn than they were at the outset of the 2008-2009 recession, said Diana Petramala, an economist with TD Bank.

"Households aren't starting in a position where they have a strong ability to take on more debt (and) continue spending despite the economic downturn and help drive a recovery," Petramala said.

"I think at this point . . . households would start to ease on their rate of borrowing and probably cut back on purchases."

Any continuation of stock market volatility could weaken consumer and business confidence, meaning that households may hold back on big ticket purchases like home buying and developers could be jittery about new builds, she added.

"Home prices in Canada are 10 to 15 per cent overvalued, particularly in Toronto and Vancouver," she said. "That certainly leaves the market susceptible to any potential economic downturn."

TD Economics has predicted that home prices will contract by about 16 per cent in 2011-2012, but Petramala said that could now happen sooner than expected.

Stock markets — although they rebounded sharply on Tuesday — have seen severe selloffs in recent days over fears about U.S. and European debt loads and the potential for a double-dip recession south of the border.

The Canadian economy is so closely linked to the U.S. that slower American growth translates into less demand for Canadian goods, and lower employment and income growth in Canada.

Those worries could soon sour the mood of real estate investors who may not want to bet on an improving economy by the time new builds go on the market.

Buyer sentiment is "vulnerable to recent market turmoil," as the large decline on stock markets has a negative effect on consumer wealth and confidence, making them less inclined to make big purchases, said CIBC economist Peter Buchanan.

"That of course can cut both ways, it can make investors fearful of buying real estate, on the other hand it does mean the Bank of Canada won't be tightening quite as early," Buchanan said.

"The other thing is that if people are worried about putting their money into the equity market, hey real estate may not look so bad."

Many observers believe the Bank of Canada may now hold its overnight rate — which affects variable mortgage rates tied to bank prime rates — at the current low one per cent until next spring. Fixed rate mortgages could also fall as bond markets react to government debt issues.

The U.S. Federal Reserve announced Tuesday that it will likely keep interest rates at record lows near zero through mid-2013. The Fed had previously said only that it would keep it low for "an extended period" and the more explicit time frame was aimed at giving nervous investors a clearer picture of how long they will be able to obtain ultra-cheap credit.

Low mortgage rates are a big incentive for buyers to get into the market, and led to rampant activity last year.

But even with low rates that make the cost of carrying a mortgage cheaper, pent up demand in the housing market could be largely exhausted.

Many buyers rushed into the market during the closing months of 2009 and early 2010, when the Bank of Canada rate was set at an emergency low of 0.25 per cent. Others decided to buy before the implementation of the new HST in Ontario and British Colombia in July 2010, or to beat two rounds of tighter lending rules.

The trend toward much higher construction on multiple-unit dwellings, and a decline in single family starts, could indicate the housing market isn't as strong as it appears at first glance. Single family homes are usually the barometer of growth in household formation and more multiple unit homes could signal more people are looking to rent.

Multiple urban starts were 13 per cent higher at 120,200 units, while urban single starts decreased by 7.8 per cent to 65,000 units.