Canadian Industrial Outlook  Winter 2011

Canada’s Residential
Construction Industry
Short-Term Risk Index
KEY ISSUES
(percentage change)
Forecast Trend Policy Changes—A further tightening of mortgage lending standards
0.4 will restrain growth in residential construction spending this year.
Production 0.3
0.2 Interest Rates—Although the Bank of Canada has temporarily moved to
Weak 0.1
0 the sidelines, further rate increases are expected, starting in the second
Prices 6 mos. 3 mos. Current half of this year. Higher mortgage rates and reduced affordability will be
Weak the result.
Cyclicality Job Creation—Canada will continue to create jobs this year, but at a slower
Profits 0.52
P pace. The resulting weaker income growth will prevent a significant rebound
Weak
in residential construction spending.
−1 0 1

KEY INDICATORS

2007 2008 2009 2010 2011f 2012f 2013f 2014f 2015f

Real GDP (2002 $ millions) 23,125 23,061 20,713 23,416 22,637 23,499 24,961 26,162 27,196
2.5 –0.3 –10.2 13.0 –3.3 3.8 6.2 4.8 4.0
Employment (000s) 526.9 570.8 533.1 616.3 594.7 611.4 642.3 666.8 689.8
5.1 8.3 –6.6 15.6 –3.5 2.8 5.1 3.8 3.4
Price index (2002 = 100) 137.4 142.1 138.8 141.9 143.6 148.3 153.1 156.6 160.3
7.7 3.4 –2.3 2.2 1.2 3.3 3.2 2.2 2.4
Revenues ($ millions) 105,993 108,658 95,752 110,545 107,936 115,759 126,930 136,016 144,741
12.4 2.5 –11.9 15.4 –2.4 7.2 9.6 7.2 6.4
Costs ($ millions) 101,656 103,686 92,667 108,601 106,096 112,870 123,085 131,838 140,284
11.9 2.0 –10.6 17.2 –2.3 6.4 9.0 7.1 6.4
Profits before taxes ($ millions) 4,337 4,972 3,085 1,943 1,840 2,889 3,845 4,178 4,457
23.7 14.6 –38.0 –37.0 –5.3 57.0 33.1 8.7 6.7
Profit margin (per cent) 4.1 4.6 3.2 1.8 1.7 2.5 3.0 3.1 3.1
f = forecast
Italics indicate percentage change.

Economic performance and trends

 CURRENT ENVIRONMENT

F
ollowing a hot start to the year, residential
construction activity in Canada closed out
2010 on a cooler note. Housing starts have
been averaging nearly 170,000 units on an annualized
basis in recent months; and despite expectations for
modest job and income growth in 2011, spending on
residential construction is expected to experience lit-
tle change over the course of this year. As a result, and
because they will compare unfavourably to the strong
numbers put up in early 2010, industry revenues on
a year-over-year basis will be down this year.
A variety of factors will limit the pace of construction
activity this year. These include a further tightening
of mortgage lending rules by the federal government
that will take effect in March and April, elevated
levels of consumer debt, and the expectation that
mortgage rates will begin to rise again in the second
half of the year. These factors will detract from
growth in spending on new housing.
In terms of existing home sales, the
market is also expected to remain
somewhat cool. The sales-to-new-
listings ratio is in balanced territory,
suggesting that price appreciation
will remain limited this year. Given
the limited price outlook, a modest
pace of existing home sales, and the
announced policy changes that will
tighten up lending standards for
home lines of credit, it is expected
that demand for home renovations—
and the ability of consumers to
finance them—will remain weak
over the course of this year.
Beyond 2011, the industry will con-
tinue to face the headwinds associated
with rising interest rates and the sub-
sequent reduction in affordability.
However, despite those headwinds,
the pace of construction activity is
expected to improve in 2012 as the
effects of lending policy changes
fade. Demographic demand will
support housing starts in excess of
185,000 units a year over the rest of
the forecast period. As well, a steadily
expanding and aging housing stock
will allow the share of residential
construction expenditures devoted
to renovations and repairs to grow.

MACROECONOMIC DRIVERS

1
Consumers Carrying Heavy Debt Loads
(ratio, consumer debt to net worth, per cent)
High debt loads, a slower pace of job and income growth, and rising
mortgage rates later this year are all factors that will limit spending on
residential construction in the near term. A continued strong pace of

24 household formations will support demand for home construction in

22 the medium term, but macroeconomic factors will contribute to a decline
20 in residential construction spending this year.
18
16
14 Debt Loads
A key motivation behind the federal government’s moves over the past 18 months
92
94
96
98
00
02
04
06
08
10
90
19

to tighten mortgage lending rules is the concern that Canadian consumers are
Source: Statistics Canada. over leveraged. There is no doubt that debt levels relative to disposable income
have steadily increased over time. By the end of 2010, this ratio had reached
a record high 137 per cent. However, it is important to keep in mind that a
variety of factors have contributed to this increase, including low interest
rates (which reduce the burden of repaying debt) and the fact that the share
of the population that has access to credit has increased over time.

It is also important to note that average net worth per person has also been
generally rising over time, and comparing debt loads to net worth tells a less
stark story. The level of consumer debt relative to consumer net worth has
been much more stable over time. The ratio did rise at the end of 2008 (see
Chart 1) when the stock market fell in the wake of the global financial crisis.

2  |  Canada’s Residential Construction Industry—Winter 2011 Find this report and other Conference Board research at www.e-library.ca
 But what is more troubling is that the ratio has not fallen since then despite
2 the rise in asset values. This implies that consumers have been borrowing at
Mortgage Rates Will Begin to Rise Later This Year a brisk pace over the past two years. For the residential construction industry,
(five-year rate, per cent) this will likely mean a reduced pace of spending growth in the near term as
9 consumers take a breather and pay down some of their debt.
8
7 Interest Rates
6 After raising rates by 75 basis points over a four-month period last year, the
5 Bank of Canada has now paused in its monetary tightening. The decision to
4 hold off on further rate hikes was triggered by rising global uncertainty and
a foundering U.S. recovery that has dampened prospects for the Canadian
01
02
03
04
05
06
07
08
09
00

f
12f
f
f
f
10
11

13
14
15
20

economy. As well, subdued inflationary pressures—in Canada and abroad—

f = forecast
Sources: The Conference Board of Canada; Statistics Canada. have helped central banks maintain fiscal stimulus without having to worry
much about igniting inflation. Indeed, overcapacity and high unemployment
3 have kept consumer prices in check in much of the developed world. Finally,
the strength of the loonie, which is now trading around parity with the U.S.
Weak Income Growth Will Restrain Spending on
Housing This Year
dollar, is also detracting from the Bank of Canada’s need to raise rates.
(real disposable income growth, per cent)
Despite the Bank of Canada’s tightening last summer, mortgage rates actually
6 declined in the second half of 2010 as concerns about the health of the economic
5 recovery kept long-term rates from rising. However, the Bank of Canada is
4 expected to begin raising rates again in the second half of 2011, and mortgage
3
rates are expected to follow. (See Chart 2.) As a result, the affordability of
2
1 new housing will deteriorate steadily over the course of 2012, preventing a
0 more robust recovery in the pace of home construction until 2013 and beyond.
01
02
03
04
05
06
07
08
09
10

15f
12f
13f
00

14f
f
11

Consumers
20

f = forecast
Employment growth slowed in the second half of 2010; and although job
Sources: Statistics Canada; The Conference Board of Canada.
creation is expected to continue through 2011, the pace of growth in both
employment and real disposable income is expected to be much weaker this
year than in 2010. (See Chart 3.) Slower job and income growth has resulted
in The Conference Board of Canada’s Index of Consumer Confidence weak-
ening since last spring. Of particular importance to the residential construc-
tion industry are the responses to the index survey’s question regarding major
purchases. Nearly half of respondents continue to say that it is not a good
time to make a major purchase.

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 INDUSTRY TRENDS

After cooling markedly at the end of last year, residential construction

4
expenditures are not expected to post a recovery this year—mortgage
Credit Quality Picture Very Different in Canada
Than in the U.S. rule changes, rising interest rates, and weaker income growth will all limit
(per cent of mortgages more than 90 days in arrears) demand. As a result, housing starts will average about 175,000 units this
Canada U.S. year, little changed from the pace of recent months. Spending will start to
6
5 improve next year, but housing starts are not expected to return to their
4 pre-recession peaks. As a result, renovation expenditures will account for
3
2 a growing share of industry revenues.
1
0
New Changes in Mortgage Lending Policy
2000 01 02 03 04 05 06 07 08 09 10
After implementing new rules that tightened mortgage lending practices last
Sources: Mortgage Bankers Association; Canadian spring, the federal government has enacted further restrictions that will take
Bankers Association. effect in March and April. Key changes include reducing the maximum amor-
tization period on government-insured mortgages from 35 years to 30 years.
That will effectively reduce the maximum price that buyers can pay for a home.
As well, homeowners will only be able to refinance their mortgages to a max-
imum of 85 per cent of the value of the home, compared with 90 per cent
previously. And mortgage insurance will no longer be available for home
equity lines of credit. These changes will reduce access to capital for renova-
tions, since refinancing and home lines of credit are two common ways to
finance renovation projects.

Fears of a U.S.-style housing crisis here in Canada are driving these changes,
as policy-makers hope to avert a crisis before it occurs. Given the high consumer
debt levels and the expectations that mortgage rates will rise in the coming
years, there is some cause for concern. However, these concerns might be
overblown. For example, the Canadian Association of Accredited Mortgage
Professionals reports that about 80 per cent of mortgages issued in this country
are fixed-rate mortgages—and are therefore much less sensitive to interest
rate movements.1 As well, despite the recent recession, mortgages that are
more than 90 days past due account for only 0.44 per cent of all current
mortgages.2 This compares with 4.3 per cent in the U.S. (See Chart 4.)
Whether the changes are necessary or not, there is little doubt that they
will detract from residential construction spending this year.

Implications of an Aging Housing Stock

Although housing starts tend to get much of the attention when residential
construction activity is being discussed, spending on renovations and repairs
is also very important. In fact, renovations and repairs account for more than
half of all spending on residential construction in Canada. As well, growth in
spending on renovations and repairs is expected to outpace spending on new

1 Will Dunning, Revisiting the Canadian Mortgage Market—The Risk Is Minimal (Toronto: Canadian
Association of Accredited Mortgage Professionals, 2011). www.caamp.org/meloncms/media/
Revisiting%20Cdn%20Mortgage%20Mkt%20Booklet.pdf.

2 Canadian Bankers Association, “Number of Residential Mortgages in Arrears.” Available at

www.cba.ca/contents/files/statistics/stat_mortgage_db050_en.pdf.

4  |  Canada’s Residential Construction Industry—Winter 2011 Find this report and other Conference Board research at www.e-library.ca
 homes over the medium to long term. This is because housing starts are
5 ultimately capped by demographic demand, but the size of Canada’s housing
Canada’s Aging Housing Stock Will Require stock—and thus the potential renovations market—continues to expand each
More Renovation Sopending year. The end result is that renovations and repairs will account for a growing
(per cent) share of total residential construction expenditures over the forecast period.
Share of housing stock
Share of homes in need of repair A key factor driving expenditures in the coming years will be the aging stock
60 of Canadian homes, which will require considerable ongoing expenditures on
50 maintenance. (See Chart 5.) At present, nearly 60 per cent of homes in Canada
40
are more than 30 years old, and about one-third of homes are in need of repair.
30
With 13.5 million households in Canada, the potential renovation market in
20
10 Canada is sizable.
0
Implications of an Aging Population
19 5

19 0

19 0

19 0

19 0

20 0
0
ea 20

−4

−6

−7

−8

−9

−0

−1
19 ier
or n 19

21

46

61

71

81

91

01
rl

As the population ages, the spending patterns of consumers are expected to

i
ilt
Bu

change, and residential construction activity will not be immune to these chan-
Sources: Statistics Canada; The Conference Board of Canada. ges. For example, the type and size of homes that people desire tends to change
with their age. A shift toward smaller units requiring less maintenance (such
6 as condo units) has already started and is expected to intensify over the next
Retirees Move Into Smaller Accomodations decade. Based on the latest census data available, the share of people living in
(share of dwelling structures by age cohort, per cent) an apartment or condo is much higher among those 65 and older. (See Chart 6.)
Houses: single-detached, Apartments and condos As well, this trend toward smaller units will be reinforced as buyers of all ages
semi-detached, and row
show an increased interest in living near urban cores. Thus, the average size
80
70 of new housing units and spending per unit are likely to shrink in the coming
60 years. At the same time, although people may opt for less floor space, they
50
40 will likely put more money into finishings and fixtures, at least partially miti-
30 gating the effect of downsizing on spending.
20
10
0
0−24 25−34 35−44 45−54 55−64 65−74 75+

Sources: Statistics Canada; The Conference Board of Canada.

FINANCIAL PERFORMANCE

Although industry revenues will experience a modest correction this year,

7
the outlook for housing expenditures remains sanguine, with strong growth
All Industry Segments Will Enjoy Healthy
expected in 2012 and beyond. Cost pressures mean that industry profits
Growth Over Medium Term
(average annual sales growth, per cent, 2012–15) will be slower to recover—and although profit growth will be healthy in the
Renovations and coming years, industry profits will struggle to return to their pre-recession
repairs
peaks before the end of the forecast period.
Detached housing
Revenues
Apartments and Industry revenues will be little changed over the course of 2011, but they will
row houses
be at a level below where they stood in early 2010. As a result, on a year-over-
Semi-detached
housing year basis, the industry will record a modest decline in revenues in 2011.
Industry revenues will experience strong growth in 2012 and beyond, driven
6.0 6.5 7.0 7.5 8.0
by both improving new construction of all types and increased renovation
Sources: Statistics Canada; The Conference Board of Canada.
expenditures. (See Chart 7.)

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 Price appreciation will be a key source of revenue growth for the industry in
8 the coming years, but this will largely be the result of the industry attempting
Building Material Prices Are on the Rise to pass increases in material and labour costs through to customers. Because
(year-over year change, per cent) each home or renovation project is a unique product, builders do have some
ability to compete on design and service rather than on price. However, compe-
Plastic pipes tition in the industry is considerable. There are many small players, builders
need to compete with the existing stock of homes, and affordability is declin-
Roofing materials
ing. These factors are expected to limit the ability of builders to enact price
Bricks and tiles increases, and this will be a key reason why margins in the industry will
remain low over the outlook period.
Wood products
Costs
Cement and concrete With revenues weakening, the industry has begun to cut costs. The largest
cuts have come from labour and material costs. On the labour front, industry
0 1 2 3 4 5 6
employment is falling modestly, but the wage bill is being cut more predomin-
Sources: Statistics Canada; The Conference Board of Canada. ately through reductions in the number of hours worked. On the materials side,
a reduced pace of building has meant reduced use of material inputs. However,
9 this is being partially offset by rising prices for most material inputs. (See
Industry Profits Will Be Slow to Return to Their Chart 8.) Products that use oil as an input, such as asphalt shingles and plastic
2008 Peak pipes, are showing the largest gains.
($ billions)
6 Cost containment will continue to be an issue for the industry this year as it
5 struggles to maintain profitability in the face of weak sales. However, costs
4 will rise along with profits in 2012 and beyond. Prices for some materials, such
3
as wood and bricks, remain below their pre-recession peak, and commodity
2
prices in general are expected to rise in the coming years. As well, the industry
1
0 is labour intensive, and wage costs are expected to experience above-average
growth due to labour market tightness, particularly for skilled trades.
01
02
03
04
05
06
07
08
09
10

f
f
00

f
13f
14f
15
11
12
20

f = forecast
Sources: Statistics Canada; The Conference Board of Canada.
Profits
Cost control in the industry means that profits are expected to post only a
small decline this year, despite lower revenues and cost pressures. Pre-tax
profits will fall to $1.8 billion in 2011, their lowest point since 2004. (See
Chart 9.) Industry profitability will steadily improve beginning in 2012,
but cost and competitive pressures are expected to keep margins tight. As
a result, the industry is not expected to return to its pre-recession peak in
profitability before the end of the forecast horizon.

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 AT A GLANCE

Main Inputs, 2007 Average Annual Output Growth Housing Starts by Province

Per (percentage change) (percentage change, 2010)

Commodity cent
Residential construction
Wholesaling margins 13.7 N.L.
Goods producing
Milwork and wood structural P.E.I.
products, excluding prefab Canada N.S.
buildings 11.8 10 N.B.
Metal doors, windows, and 8
Que.
other building products 5.0 6
Ont.
4
Other plastic products 4.3 Man.
2
Lumber and timber 4.3 0 Sask.
Transportation margins 3.6 −2 Alta.
Architect, engineering, legal, −4 B.C.
and accounting services 3.0 2001−05 2006−10 2011−15f
−20 −10 0 10 20 30 40 50 60 70
Ready mix concrete 2.7
f = forecast
Other financial intermediary Sources: The Conference Board of Canada; Sources: The Conference Board of Canada;
and real estate services 2.7 Statistics Canada. Statistics Canada.

Asphalt building products and

building paper 2.2
Residential Share of Construction Output
Concrete products 1.7
Textile floor covering 1.6 (percentage share of total construction GDP)
Plywood and veneer 1.5
Residential Non-residentia l Engineering
Other wood end products 1.5
100
Paints and related products 1.2
Metal and plastic plumbing 80
fixtures and fittings 1.2 60
Plastic pipe and pipe fittings 40
and other rubber end products 1.2
20
Sources: The Conference Board of Canada;
Statistics Canada.
0
2000 01 02 03 04 05 06 07 08 09 10
Sources: The Conference Board of Canada; Statistics Canada.

Pricing Power Capital Intensity, 2010 Labour Intensity, 2010

(price index, 2002 = 100) (2002 $ 000s, capital stock per employee) (workers per $1 million of real output)

Residential construction CPI

180 Residential
Residential
construction
160 construction
140 Goods-producing Goods-producing
120 industries industries
100
80 All industries All industries
99
01
03
05
07
09
f

f
f
97

11

15
13

0 50 100 150 200 0 10 20 30

19

f = forecast
Sources: The Conference Board of Canada; Sources: The Conference Board of Canada; Sources: The Conference Board of Canada;
Statistics Canada. Statistics Canada. Statistics Canada.

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 USER GUIDE

Risk Index Cyclicality

This risk index is a leading indicator cre- The cyclicality indicator is calculated by
ated by The Conference Board of Canada. The Conference Board of Canada as the
It provides an early indication of turning correlation between GDP growth in the
points in the industry’s performance. In industry and the economy as a whole.
the case of the residential construction The number is bound between −1 and
industry, components of the index include 1. A value close to one indicates that
Statistics Canada’s composite leading movements in the industry’s output are
indicator, the unemployment rate, the strongly correlated with movements
five-year conventional mortgage rate, in the national economy and are thus
and personal income. The reported num- cyclical. A value close to zero indicates
ber is the six-month moving average of no relationship between the national
the month-to-month growth in the index. economy and the industry, while a
Thus, the higher (lower) the number is, negative value implies that growth in
the stronger (weaker) the industry’s profit the industry is inversely related to the
prospects are. The chart provides the economy’s performance.
current growth rate and what it was
three months ago and six months ago,
to give the reader an idea of how the
industry’s risks are changing over time.

Key Indicators
Real GDP
Real gross domestic product (GDP) is a standard measure of industry
output and is equal to the total value that an industry creates. As such,
it is a measure of the industry’s contribution to economic growth. It is
stated in millions of 2002 dollars and is reported by Statistics Canada.
Revenues
Revenues are the total receipts that an industry accumulates. They are a
product of pricing and of production (which is equivalent to sales in 2002
dollars). The data are reported by Statistics Canada as part of its Quarterly
Financial Statistics for Enterprises and are stated in millions of dollars.

Employment
Employment is the total number of full-time and part-time employees in
a given industry. As part of its Labour Force Survey, Statistics Canada
reports employment data monthly, in thousands.
Price Index
This indicator is a composite measure of the output prices for all of an
industry’s products. The data for this series come from the Industrial
Product Price Index produced by Statistics Canada. All price indexes
are standardized in the form of an index where 2002 = 100.
Costs
Costs are the sum of labour, material, and capital costs for each indus-
try, where capital costs include both interest expense and depreciation
expense. The data are reported by Statistics Canada as part of its Quarterly
Financial Statistics for Enterprises and are stated in millions of dollars.
Profits
Profits are equal to revenues less costs and are stated before taxes or
extraordinary items. The data are reported by Statistics Canada as part of
its Quarterly Financial Statistics for Enterprises and are stated in millions
of dollars.

Profit Margin
The profit margin is the ratio of profits to revenues.

8  |  Canada’s Residential Construction Industry—Winter 2011 Find this report and other Conference Board research at www.e-library.ca
 USER GUIDE (cont’d)
Main Inputs
This table lists the industry’s major
material inputs. The purpose is to
indicate the industry’s sensitivity to
changing prices for its various inputs.
This information is based on the input-
output tables produced annually by
Statistics Canada. It is reported in this
table as a share of the total value of
material inputs into the industry.
Pricing Power
This chart compares the residential con-
struction industry’s output price index
with the Consumer Price Index (CPI). It
indicates whether prices in the industry are
rising faster or more slowly than average
overall prices over time. Industries with
above-average price appreciation are able
to consistently raise prices faster than the
rate of broad inflation and generally have
pricing power. Industries with weak price
appreciation generally have poor pricing
power. Both price indexes are bench-
marked so that 2002 is equal to 100.
Capital Intensity
Capital intensity is a measure of how much
capital stock—which takes the form of
machinery, equipment, and non-residential
structures—there is per employee in the
industry. High capital intensity can be a
barrier to entry in an industry, limiting
competition. Industries with higher capital
intensity also generally have higher levels
of output per employee. For comparison
purposes, the chart displays the capital
intensity of the residential construction
industry, of all goods-producing industries,
and of all industries in Canada.
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Residential Share of Construction Output
This chart displays the breakdown of total con-
struction output by industry: residential construc-
tion, non-residential construction, and engineering
construction. The purpose is to track the compos-
ition of the overall sector. The chart is based on
GDP data produced by Statistics Canada and on
estimates from The Conference Board of Canada.
Average Annual Output Growth
This chart compares the average annual
GDP growth of the industry with that of
all goods-producing industries and of all
industries in Canada. The comparison is
provided over three different time periods:
two historical and one forecast. This pro-
vides an indication of how the industry
has performed and will perform relative
to the rest of the economy at different
periods in time.
Housing Starts by Province
This chart displays growth in housing
starts broken down by province. The
purpose is to show where the residential
construction market is buoyant. The chart
is based on housing starts data produced
by Statistics Canada.
Labour Intensity
Labour intensity is a measure of how
much labour it takes to produce a unit of
output. Labour costs constitute a higher
portion of overall costs for industries with
higher labour intensity. Industries with
higher labour intensity that produce trad-
able goods or services are also generally
more susceptible to competition from low-
wage countries. For comparison purposes,
the chart displays the labour intensity of
the residential construction industry, of
all goods-producing industries, and of all
industries in Canada.
 The Canadian Industrial Outlook Service includes detailed five-
year forecasts in 16 key Canadian industries. The report examines
the short- and medium-term economic and profitability outlooks
for the following industries: oil extraction, gas extraction, residen-
tial construction, non-residential construction, food products, paper
products, motor vehicles, motor vehicle parts, aerospace products,
air transportation, food services, accommodation, telecommunica-
tions, computer systems design, computer and electronic product
manufacturing, and wood products. Outlooks for several financial
and economic variables—prices, production, revenues, expenditures,
profits, gross domestic product, and employment—are generated
based on forecasts of key domestic and international factors such as
interest rates, exchange rates, and tax policy. The Conference Board’s
Canadian Outlook Executive Summary is presented in a separate
publication to set the stage for the Canadian economy.
The Canadian Industrial Outlook is updated twice a year using the
Conference Board’s econometric and financial model. The publication
can be accessed online at www.e-library.ca and, for clients subscribing
to e-Data, at www.conferenceboard.ca/edata.htm. For more informa-
tion, please contact our information specialist at 613-526-3280 or
1-866-711-2262, or by e-mail at contactcboc@conferenceboard.ca.

Canada’s Residential Construction Industry

by Michael Burt

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