Rosalind Evans
This could hinder the Bank of Canada’s potential rate cuts for this year
Canada’s housing market correction last year surprised analysts with its swift pace. The same can now be said for its recovery. Anticipations of the market bottoming out this spring seemed confirmed by April’s performance, according to RBC assistant chief economist Robert Hogue.
“Preliminary data from real estate boards strongly suggest that local markets shifted gears last month,” said Hogue. Both sales and prices increased across most markets, with Vancouver, Toronto, and Calgary leading the charge. Sales in Montreal, experiencing a prolonged downturn, rose by 12% compared to the previous month.
Sales in Toronto saw a significant leap of 27% in April compared to March. Although new listings also experienced a boost, more was needed to meet demand, resulting in market conditions as tight as those before the correction, Hogue noted.
Meanwhile, a prominent analyst from Bay Street warns that Canadian banks’ earnings could be in jeopardy due to exposure to office real estate. Commercial real estate loans are the second-most significant lending exposure of the six largest Canadian banks, falling behind only residential real estate, which accounts for around 10% of lending portfolios, as per National Bank Financial analyst Gabriel Dechaine.
Dechaine noted that the commercial real estate portfolio has grown in size and expanded faster than the wholesale portfolio over the past seven years. Office sector exposure, which constitutes 12% of the Big Six banks’ average commercial real estate book, is especially concerning due to the rise of remote work leaving many office buildings underutilized and decreasing rental prospects.
Drawing parallels from the financial crisis of 2008 and the early 1990s recession and real estate downturn, Dechaine proposed that the potential decline in earnings per share could reach high single digits or exceed 20%, albeit more likely towards the lower end that spectrum.
Despite these predictions, Dechaine reassured that any large banks would unlikely fall beneath the minimum capital cushions mandated by regulators.
In contrast, other market observers have voiced less concern over Canadian banks’ ability to manage their exposure to commercial real estate. CPA Canada’s chief economist David-Alexandre Brassard expressed in an April 5 column that the major banks are well-equipped to handle historically high vacancy rates and increased interest rates. He pointed out that commercial real estate accounts for only 2% of their total assets, as opposed to 13% for U.S. banks.
The swift recovery of the Canadian housing market has implications for the Bank of Canada’s monetary policy. If the market strengthens, the central bank may reconsider lowering interest rates this year. Such a move would prevent an overheat of the real estate sector, which could have widespread effects on the national economy.
On the commercial real estate front, despite the rising concerns, Dechaine stated that Canadian banks have yet to see a substantial increase in impaired commercial real estate loans. However, he noted that the banks could be more transparent about their set-aside provisions in their commercial real estate portfolios, especially considering U.S. banks have flagged two to three percent provisions.
“In the face of a potential commercial real estate downturn, especially in the office sector, investors are understandably questioning coverage ratios,” Dechaine said.
He further suggested that due to the possible overhang of commercial real estate and the continuing volatility in the U.S. regional banking sector, which could precipitate a recession, many investors are likely to be cautious about the Big 6 banks.
His analysis showed that three central banks — the Bank of Montreal, Toronto-Dominion Bank, and National Bank — have approximately 10% exposure to office real estate. In contrast, the Royal Bank of Canada has the highest exposure among the group, nearing 20%.
The Canadian housing market’s swift recovery has implications for both domestic monetary policy and the financial stability of the nation’s leading banks. The interplay between residential and commercial real estate markets, driven by changing work habits and economic conditions, is a key space to watch in the coming months.
