A new report by the International Monetary Fund (IMF) found that Canada’s housing market has grown riskier over the last two years. But recent policy changes may help prevent a crisis.
In its recent Global Financial Stability Report, the Washington-based IMF reported that Canada has replaced the U.S. as a high-risk housing market. While lower household debt and cheaper home prices have lessened risk in the U.S., an influx of cash from foreign buyers has significantly increased risk in Canada.
However, the report also found that recent increases in foreign buyer taxes and tightened mortgage regulations may keep the situation from escalating.
Foreign Buyers Driving Up Risk
In some cases, investments by foreign entities can benefit housing markets. For example, foreign real estate trusts buying apartment buildings can promote stability. But according to the report, foreign individuals buying individual homes:
“Seem(s) to be associated with higher house prices in the short term and more downside risks to house prices in the medium term in advanced economies.”
Generally, Vancouver has the strongest reputation for attracting foreign buyers. Yet the report found that the Calgary real estate market has been more destabilized by foreign purchases than Vancouver’s. Apparently, that may be tied to the boom-and-bust cycles of Alberta’s oil industry.
Provincial governments in the Toronto and Vancouver areas have introduced foreign buyers’ taxes that, according to the IMF, may alleviate overvaluation pressure and thereby reduce risks. Vancouver originally introduced a 15% tax on residential properties purchased by foreign nationals in July 2016. In February 2018, the government increased the rate to 20% and expanded the tax’s reach to include the Fraser Valley, Capital Regional District, Nanaimo Regional District and the Central Okanagan.
Another solution the report recommended is tightening regulations related to how much money homebuyers can borrow relative to their income. “Macroprudential measures” reduce risk by forcing homebuyers to apply for mortgages that are more within their means.
This method was recently employed by Canada’s banking regulator, The Office of the Superintendent of Financial Institutions (OSFI), who created a mortgage stress test. The test effectively requires borrowers to qualify for a mortgage at a rate that’s 2% higher than the mortgage they applied for.
Despite the IMF report’s findings that such limitations reduce risk in the housing market, the mortgage stress test led to widespread commotion among residential real estate professionals. For them, the tightened rules reduced their customer base by forcing some would-be buyers out of the market.
A study by RateHub found that before the stress test, an average homebuyer in Toronto qualified to purchase 43% of listed homes. But with the stress test, the study found those same buyers qualified to purchase only 20%.
Numerous industry groups called for the government to loosen or eliminate the stress test, arguing that it contributes to a growing housing affordability crisis.
In late 2018 the Royal Bank of Canada (RBC) Economics found that housing affordability levels were at their worst point in almost 30 years. The RBC report concluded that high interest rates led to families with an average income in Vancouver spending a shocking 88.4% of their income on housing.
Aid from the Government
In response to the complaints by the residential real estate industry, the federal government is developing a First Time Home Buyers Incentive program. The goal of the program is to reduce buyers’ monthly mortgage payments by having Canada’s government-run mortgage insurer, Canada Mortgage and Housing Corporation (CMHC), buy a stake in the homes. The CMHC would eventually recover its money when the home is sold.
Scheduled to launch in the fall, the program could have the side effect of slowing the market until the time when it comes into effect. Current buyers may choose to wait a few more months until they can benefit from the government’s help.
The CMHC says the program will likely only raise home prices by a fraction of a percentage point. They also argue that helping first-time buyers purchase their homes will free up rental openings. That, they say, should also ease pressure on rents.