Interest rates, material costs forcing construction delays, cancellations

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Special to Ontario Construction Report

Residential construction projects are being moved to the back burner until the outlook for interest rates and other costs improves, developers say, noting that Bank of Canada rate hikes in June and July had an especially “chilling effect” on the GTA condominium market. They say project delays and cancellations could add to a supply imbalance and make it even more difficult for policy makers to meet ambitious home building targets.

As higher rates cool construction there will be effects on supply and “upward pressure on prices,” said Toronto-area builder Barry Fenton who suggested the central bank has moved “too far and too fast.”

But Fenton, who is president and CEO of Toronto condo developer Lanterra Developments Ltd., said construction will come roaring back once stakeholders believe that the tightening cycle has run its course, adding that he’s convinced the worst of the housing market correction in Canada is over.

Until then he said builders are looking for more certainty on borrowing, labour and material costs after sharp runs ups but said the housing market in the GTA remains fundamentally strong underpinned by historically large population increases.

Following a 25-point hike in June the Bank of Canada delivered another 25-basis point in July to push its policy rate to five per cent as part of a campaign to tap inflation down to the midpoint of a target range between 1 and 3 per cent.

The move marked the highest point for the Bank of Canada’s interest rate in 22 years. Higher rates have slowed new building intentions and kept some buyer on the sidelines which in turn led to a slight drop in new home prices, according to a new report from Century 21 Canada.

The data came from the Century 21 Canada’s annual “Price per Square Foot survey,” shows centres such as Toronto, Vancouver and Montreal are experiencing lower condo prices, while smaller markets are seeing significant price-per-square-foot growth, particularly in single-family homes.

In August, the Canada Mortgage and Housing Corp., meanwhile, reported housing starts at 254, 966 annualized units in July, representing a 10 per cent month-on-month decline from June’s level of 283,498 as higher interest rates weighed on builders and buyers alike. Ontario and B.C. drove much of the decline.

The six-month average shows starts remain well above pre-pandemic levels and have picked up some steam in recent months but are well off their peaks from late last year thanks to less construction of single-detached units, TD economist Rishi Sondhi said in a note to clients.

“Moving forward, we think starts will trend lower, as last year’s multi-year lows for home sales feed through into weaker homebuilding,” he said. “This would be consistent with building permits, which are pointing to a much lower pace for starts.”

The Canadian Home Builders’ Association (CHBA) said  a pause from the Bank of Canada on increasing interest rates between late January and June of this year allowing buyers time to adjust to the new financing environment and helped  support an improvement in builder sentiment, although the June and July interest hikes will no doubt keep the improvement muted.
“They’ve had a real chilling effect,” CHBA CEO Kevin Lee said of the not widely expected increases.

He said affordability challenges related to interest rates and construction costs remain very much a concern and have been compounded by the July hike by the Bank of Canada shortly after data from a second quarter survey of builders’ sentiment was collected from about 200 CHBA member firms and industry experts, many in the GTA.

Converting prospective buyers into sales remains a challenge, as do closings from previous sales. Due to the high interest rate environment, nearly half of those surveyed reported that buyers are requiring alternative lending solutions and one third said they are needing to make accommodations for some buyers so they can close.

At the same time, fewer sales means less new construction, and the concern regarding the shortage of housing in Canada is increasing, the CHBA says. Sixty-seven per cent of the industry panelists surveyed stated that the slowdown in the market is causing them to build fewer units. Twenty-two per cent said the slowdown is causing them to cancel projects entirely.

“We need to build 5.8 million homes within the next ten years to close Canada’s current housing supply gap. Current conditions – with construction costs rising, labour shortages, and especially the current financing conditions – are preventing that from happening,” Lee said.

In a report, meanwhile, real estate research firm Urbanation said GTA new condominium sales increased 118 per cent quarter-over-quarter but fell 35 per cent annually to 4,610 units in the second quarter. Sales were 28 per cent below the 10-year second quarter average of 6,370 units. For the first half of 2023, the 6,727 units sold was down 59 per cent from first half 2022 (16,272) and 42 per cent below the first half 10-year average (11,516), representing the slowest first six months of the year since 2013.

The average price for available new condominiums decreased 1.3 per cent quarter-over-quarter and 2.2 per cent year-over-year to $1,411 per square foot, representing the first annual price decline for GTA new condos in 10 years. In addition to reducing prices, many projects continued to offer purchaser incentives, which included cash back/credits on closing, mortgage rate guarantees, and free or reduced parking/locker/unit upgrades, among others.

As demand shifted towards lower-priced projects in the GTA, the average sold price for new launches decreased to a seven-quarter low of $1,236 per square foot in the second quarter, down 8 per cent annually.

The GTA construction industry is facing significant resource constraints as the number of starts continues to run well ahead of the capacity to deliver new units. Over the last four quarters, construction starts totaled 27,537 units, more than 10,000 units above the number of completions over the same period (17,117 units), pushing the total for condos under construction to a record high 102,448 units.

“As the population expands at a record pace, the GTA’s 12-month running total for new condo sales has dropped to its lowest level since 2009,” said Urbanation president Shaun Hildebrand.

“This will soon begin to impact construction and eventually cause serious supply shortages in a few years, the extent of which will depend on how long the current slowdown in presale activity persists.”

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