Merrill Lynch - Housing Report

By David Wolf of Merrill Lynch


We’ve seen a handful of more hopeful signs in the Canadian housing market of late. Demand appeared to rebound in February after an awful January, with resale activity reviving somewhat – Toronto, Calgary and Vancouver reported monthly sales increases of 54%, 51% and 94%, respectively, each well in excess of the usual seasonal bounce, suggesting a nationwide pop when those data are released later this month. And the needed supply adjustment is unfolding even faster than we’d expected – housing starts have fallen 46% over the past year, with more than a third of that drop coming just in the past two months. This decline in starts (along with project cancellations) has finally begun to bring down the bloated supply pipeline – the number of units under construction across Canada is now falling on a y/y basis for the first time since 1996.

While these are positive developments, to be sure, this looks to us far more like the ‘end of the beginning’ than the ‘beginning of the end’ of Canada’s housing bust. That is, we believe we’re transitioning from acute weakness to chronic downward grind, not imminent stabilization and recovery.

First, these sorts of near-term ‘pops’ in demand are common through sustained housing market downturns, apparently reflecting spasms of hope that the market has ‘finally fallen far enough’. Through Canada’s bust of the early 1990s, existing home sales actually troughed fairly early on in May 1990, and posted their biggest monthly gain ever in February 1991 – but prices did not put in a definitive bottom for another five years. Through the current US bust, existing home sales have in fact tried to trough twice – bouncing between September 2006 and February
2007, and again between April and September last year. But far from stabilizing, US house prices appear to have re-accelerated downward of late.

To be confident in a durable rebound in housing demand in Canada, we must be able to project a sustained improvement in consumer fundamentals, the most important of which is employment. We cannot do that – our base case projection sees the unemployment rate rising above 9% in early 2010 from its current 7.2%.


Second, the supply adjustment still looks to have a long way to go. In the US, housing under construction peaked in January 2006 at 53% above the long-term average and 27% above the late 1980s peak; three years later, the adjustment is still ongoing. In Canada, units under construction peaked just last June, and despite the adjustment since, January’s level was still 85% above the longer-term average and 46% above the late 1980s peak (see Chart 3). Moreover, two-thirds of that pipeline is multiples (largely condos), the highest proportion since 1973; those longer-lived projects will still be rolling onto the market for years to come.

Housing busts almost inevitably take a long time to play out, because supply lags badly and sellers tend to be loath to mark prices down enough to clear the market. We do not expect the current Canadian cycle to be any exception.