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What Happened In The First Quarter of 2024 And What Is Going On With The Canadian Housing Market

Congratulations! We've concluded the first quarter of 2024, and what a wild ride it has been. As we reflect on the past few months, it's evident that numerous noteworthy events unfolded. However, one overarching theme that significantly impacted Canadians' personal finances is the housing market.

* Universe: TSX 100. Total returns shown.

THE QUARTER IN MARKETS

Q1 concluded with remarkable vigor, marking an eventful start to the year for investors. The standout headline of the past three months was the continued bullish momentum in the stock market. The performance of U.S. stocks during this period ranked among the top 20% of quarters in nearly a century, following a robust 2023 where the S&P 500 and TSX saw significant gains of 25% and 9.4%, respectively.

The buoyancy in the market can be attributed to a series of unexpectedly positive developments throughout Q1. Strong corporate profits, coupled with the absence of significant inflationary pressures and spikes in unemployment, provided a favorable backdrop for equities. Pro investors, initially cautious at the start of the year, swiftly shed their reservations in the face of such encouraging news.

Individual investors also re-entered the market with gusto, contributing to the resurgence in trading activity. This surge in participation extended beyond traditional assets, with speculative assets like Bitcoin experiencing heightened interest. Options trading volume soared, largely fueled by the unprecedented demand from individual investors.

While there's always a lingering concern about the potential for speculative excesses leading to another bubble, the prevailing sentiment on Wall Street remains largely unconcerned. As long as companies continue to generate robust cash flows and inflation remains subdued, the prevailing optimism is expected to persist into Q2. Here's to hoping for a continuation of favorable conditions as we embark on the second quarter of the year.

Understanding The Canadian Housing Market

Canada’s housing market is facing an uphill battle. The pandemic exacerbated an already simmering crisis, as Canada's population surged while new construction failed to keep pace. Recent data from RBC reveals that only 45% of Canadians can now afford a condo, down from 60% in 2019, and a mere 26% feel they can afford a single-family home. Renting isn't any more affordable, adding to the housing crunch. The severity of the crisis is evident in a poll where 70% of Canadians, including homeowners, express a desire for home prices to decrease. Additionally, the same poll highlights that Canadians believe increasing the housing supply is the most effective measure to temper the overheated market.

Canada's housing market ranks first for experiencing the fastest-growing home prices among G7 nations.

Inflation-adjusted house prices, 2000 average = 100.

What are potential solutions to the housing crisis?

The housing crisis in Canada is largely attributed to supply shortages. Estimates suggest that Canada needs to construct anywhere from 5.8 million to nearly 10 million new homes within the next decade to address affordability concerns. However, with only 235,000 new homes built last year, achieving such a goal seems daunting. Can it be accomplished? Housing experts outline three key factors necessary to come close to meeting this ambitious target:

1. Embrace Vertical Growth and Increase Density:

One of the major obstacles to housing affordability in Canada is the prevalence of single-family homes. Dating back to 1916 with Berkeley, California, adopted the first single-family zoning rules in North America (for discriminatory reasons), many Canadian cities followed suit, restricting the construction of large apartment complexes in numerous neighborhoods. Today, approximately 60% of Calgary remains zoned exclusively for single-family dwellings.

Experts emphasize that Canada cannot effectively tackle the housing crisis without allowing for more medium-sized housing units, such as townhomes and walk-ups, to be built in urban areas. This approach, while seemingly radical, is common in many European cities where single-family zoning is virtually nonexistent. Some Canadian cities like Toronto and Ottawa have begun to loosen zoning regulations, but British Columbia stands out with its comprehensive changes. As of June 30, B.C. municipalities will automatically permit the construction of four- or six-unit complexes on lots currently zoned for single-family homes. While other cities and provinces must adopt similar policies, B.C.'s zoning reform alone could result in over 130,000 multi-unit homes being built over the next decade.

2. Implement Smarter Building Practices:

Canada not only needs more apartments but also a variety of apartment types, particularly those suitable for families. As cities transition away from single-family homes, adequate housing for families becomes crucial. Currently, while there may be around 150 apartments available for rent in Halifax on a listing site, narrowing the search to "three-bedroom" results in only two listings. This scarcity is partly due to the prevalence of wood construction in Canadian apartment buildings, as opposed to concrete, which is more common in Europe.

Fire codes in Canada typically mandate that apartment buildings taller than two stories have at least two stairwells, leading developers to design long, narrow units that are not family-friendly. However, many policy experts argue that this requirement is outdated, especially considering the advancements in sprinkler systems, which have significantly improved building safety. By reducing the stairwell requirement to one in mid-rise buildings, as is common in Europe, developers can maximize land usage by constructing larger or more spacious apartments.

3. Invest in Housing, Not Just Homebuyers!

While increasing housing supply is crucial to addressing the housing crisis, experts emphasize the importance of also reducing demand. Historically, Canada had a significant stock of public housing, with non-market units accounting for 25% of homes in 1970. However, in the 1990s, Ottawa slashed funding for public housing programs, transferring responsibility to provinces and cities. Instead, the government began incentivizing homebuyers through tax breaks and allowing them to leverage the equity in their current homes to purchase additional properties. This policy shift has contributed to a situation where one in three homebuyers in Canada is an investor.

While providing tax breaks to homeowners can be justified in certain circumstances, in Canada, it has exacerbated demand in an already overheated market. Researchers at the University of British Columbia argue that Canada needs to construct at least one million non-market homes over the next decade to alleviate pressure on privately owned housing.

What does all of this mean for typical Canadians?

Affordability in housing is typically defined as households spending no more than one-third of their monthly income on rent or mortgage payments. Currently, however, our calculations indicate that the average Canadian couple who own an average-priced home—currently valued at $776,300—are allocating 49% of their monthly income towards their mortgage. While some anticipate this ratio to decrease with potential interest rate cuts by the Bank of Canada soon, it's unlikely that affordability will significantly improve. Any meaningful enhancement in affordability would necessitate home prices to decline by at least 15% annually over the next few years, according to our analysis. Alternatively, significant wage increases would be required, although this scenario appears less likely.

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