Canadian Housing Policy: Still Waiting After All These Gains
Early this year, we argued that “policymakers need to act immediately, in some form, to address the home price situation before the market is left exposed to more severe consequences down the road”. So far this year, the benchmark home price has jumped another 20%, and ‘excess’ housing transactions above and beyond pre-COVID norms have totaled roughly $180 bln. We continue to believe that underlying market conditions are well rooted in supply and demand fundamentals, but the excess that we’ve seen this year is a demand-side phenomenon, fueled by market psychology and historically-low interest rates. Now, after a widely-discussed speech this week, it appears that the Bank of Canada is tuning in.
Here are three key areas that are currently in focus:
Investment demand has surged. Although it was downright obvious to us early this year that market psychology had changed, it is now showing up in the data. Early in the year, surveys of home price expectations surged to levels clearly not normal for the Canadian market. As an example, a weekly Bloomberg/Nanos poll showed nearly 70% expecting higher home prices by early spring, well above steady norms of just below 50%. The data presented by the Bank of Canada this week on investor demand matched this psychological shift almost perfectly. That is, while first-time and repeat buyers saw a roughly 50% increase in mortgage activity since the pandemic started, lending to investors (i.e., multiple-property owners) has doubled—the most significant increase has come since early this year. Now, it’s certainly not the case that all “investment” is bad, as we need rental stock in this country. But, raise your hand if you’ve seen houses in your area flip hands three times this year [hand goes up]. That’s the speculative aspect that we, and probably now the BoC, are concerned about.
Leverage has increased. The Bank noted that the share of highly-leveraged households is increasing, as measured by loan-to-income ratios in excess of 450%. Prepandemic, around 15% of originations was the norm for this segment. That share has now jumped above 25%. Of course, this is just a response to record-low interest rates, and likely makes the economy more sensitive to higher rates down the road.
Buyers shifting to variable. Another piece of the story that the Bank didn’t mention was the rapid take-up of variable-rate mortgages during this latest run in home prices. In fact, variable-rate originations exceed fixed for the first time going back to at least 2013 (fixed is usually by far more popular in Canada). This is clearly a market response to higher fixed rates, which were sub-2% until about the spring, but are now up around 2.5%. The swing to variable means that the market is still, at the margin, feasting on mortgage rates around 1.5% even as the longer end of the yield curve has backed up. This shifts the pressure squarely back on the Bank of Canada (which controls those variable rates). Keep in mind that a 100 bp rate increase from 1.5%, all else equal, would take about 8-to-10% off a home price to maintain the same monthly payment. So, like in the 2017-18 tightening cycle, this will probably be what ultimately softens the market.
Bottom Line: We’ll wind down the year with the same message that we started it. Excess demand is driving Canadian home prices right now and, while policymakers can tweak around the edges with taxes, qualification rules and other ‘affordability-enhancing’ measures, it will ultimately take higher interest rates to calm down.
Read more
Robert Kavcic
Director and Senior Economist
Robert has been with the Bank of Montreal since 2006. He plays a key role in analyzing economic, fiscal and real estate trends in Canada. Robert regularly contribut…(..)
View Full Profile >Early this year, we argued that “policymakers need to act immediately, in some form, to address the home price situation before the market is left exposed to more severe consequences down the road”. So far this year, the benchmark home price has jumped another 20%, and ‘excess’ housing transactions above and beyond pre-COVID norms have totaled roughly $180 bln. We continue to believe that underlying market conditions are well rooted in supply and demand fundamentals, but the excess that we’ve seen this year is a demand-side phenomenon, fueled by market psychology and historically-low interest rates. Now, after a widely-discussed speech this week, it appears that the Bank of Canada is tuning in.
Here are three key areas that are currently in focus:
Investment demand has surged. Although it was downright obvious to us early this year that market psychology had changed, it is now showing up in the data. Early in the year, surveys of home price expectations surged to levels clearly not normal for the Canadian market. As an example, a weekly Bloomberg/Nanos poll showed nearly 70% expecting higher home prices by early spring, well above steady norms of just below 50%. The data presented by the Bank of Canada this week on investor demand matched this psychological shift almost perfectly. That is, while first-time and repeat buyers saw a roughly 50% increase in mortgage activity since the pandemic started, lending to investors (i.e., multiple-property owners) has doubled—the most significant increase has come since early this year. Now, it’s certainly not the case that all “investment” is bad, as we need rental stock in this country. But, raise your hand if you’ve seen houses in your area flip hands three times this year [hand goes up]. That’s the speculative aspect that we, and probably now the BoC, are concerned about.
Leverage has increased. The Bank noted that the share of highly-leveraged households is increasing, as measured by loan-to-income ratios in excess of 450%. Prepandemic, around 15% of originations was the norm for this segment. That share has now jumped above 25%. Of course, this is just a response to record-low interest rates, and likely makes the economy more sensitive to higher rates down the road.
Buyers shifting to variable. Another piece of the story that the Bank didn’t mention was the rapid take-up of variable-rate mortgages during this latest run in home prices. In fact, variable-rate originations exceed fixed for the first time going back to at least 2013 (fixed is usually by far more popular in Canada). This is clearly a market response to higher fixed rates, which were sub-2% until about the spring, but are now up around 2.5%. The swing to variable means that the market is still, at the margin, feasting on mortgage rates around 1.5% even as the longer end of the yield curve has backed up. This shifts the pressure squarely back on the Bank of Canada (which controls those variable rates). Keep in mind that a 100 bp rate increase from 1.5%, all else equal, would take about 8-to-10% off a home price to maintain the same monthly payment. So, like in the 2017-18 tightening cycle, this will probably be what ultimately softens the market.
Bottom Line: We’ll wind down the year with the same message that we started it. Excess demand is driving Canadian home prices right now and, while policymakers can tweak around the edges with taxes, qualification rules and other ‘affordability-enhancing’ measures, it will ultimately take higher interest rates to calm down.
What to Read Next.
Canadian Existing Home Sales (Oct.) — The Fire Still Burns
Robert Kavcic | November 30, 2021 Commercial Real Estate
Canadian existing home sales jumped 8.6% in seasonally-adjusted terms in October (-11.5% y/y), and the market has fully firmed up again after 'sl…
Continue Reading>
Tell us three simple things to
customize your experience
