Welcome to Part Two of Urbaneer’s Winter Forecast for 2015.
In Part One, we studied what the pundits had to say about potential activity in the market- backed up by a whole lot of data; we also looked at the ongoing possible challenge that the condominium market presents. In Part Two, we are going to delve into the potential impact that the results of the recent Federal Election and the change in government could have on the housing markets; we’re also going to discuss the ongoing challenges around affordability in the City of Toronto.
A Shifting Political Landscape
No matter what your political stripes, the recent Canadian election was significant - and not just because of the shift in power. The results of this election will not only figure into our social policy - but will play a noticeable role in matters of personal finance, the economy - and by extension the Canadian housing market. And this time around, it seems that there are several factors present that could potentially soften the market.
Historically, the government has always played a role in the housing market; it’s just more apparent during certain administrations and during certain economic periods. For instance, in the wake of the sub-prime mortgage crisis that leveled the American economy and took a good swing at the rest of the globe, Canada, like other countries were realizing the inherent vulnerabilities that exist within the economy and its relationship with the housing market.
As such, then-Finance minister Jim Flaherty, followed by Jim Prentice, introduced a series of checks and balances meant to rein in the housing market. Changes including reducing the amortization period of mortgages, and removing certain shelter products from CMHC insurability. While this didn’t do much to necessarily cool the market, it did eliminate those who were on the fringes of housing affordability and were in a precarious borrowing position to begin with based on a) the variability of interest rates and b) hot housing prices forcing some to borrow beyond what should be comfortable. Urbaneer has written often about CMHC and affordability, like in this recent post “Should I Max Out My House Hunting Budget With CMHC Mortgage Loan Insurance?”
The CMHC has recently raised its premiums by 15 percent for what they deem to be high risk borrowers
New Finance Minister Bill Morneau may have to follow suit behind the Conservative predecessors to proactively manage the housing market, introducing safeguards and checks and balances. Here is an article from the Globe and Mail that muses over his possible plan of attack called “Canada’s New Finance Minister Urged To Cool Down Housing Market”.
Right now there's a lot of speculation we may see the minimum down payment increase from its current 5% down to a sum in the range of 7% to 10%. At the moment, a Buyer can purchase a house for $999,999 and put just 5% - or $50,000 - down but the moment one goes over $1,000,000 a Buyer must put 20% down. This is one of reason why the freehold housing market under $1mil in Toronto is so hot, as there's a tremendous gap between Buyer wealth under and over the $1mil mark. If the minimum down payment is increased, cash poor Buyers will be funneled into less expensive properties which, in Toronto, means the more affordable condominium market. This isn't necessarily a bad thing, as it creates a larger pool of Buyers to support the exponentially larger supply of condominiums in Toronto. In fact, at any given time there are ten times more condominiums for sale in the city core than houses. Increasing the minimum down payment would help mitigate the potential oversupply of condominiums we fear by channeling more first-time or financially-constrained Buyers into this housing type (although given the significant shortage of 2 and 3 bedroom condominiums in Toronto they simply may not buy). By economically directing Buyers into condominiums, it may slow down the filtering of housing up the property ladder initially but - as prices stratospherically continue to rise - this is already our reality. Today, the gap in values between all housing types - 1, 2 and 3 bedroom condos and 2, 3 and 4 bedroom houses - are significant. The cost to get another bedroom is substantial even in our current downtown property market.
While increasing the minimum down payment is economically strategic for the well-being of our real estate market, the sad truth is that it will shut the door on many Buyers from ever owning a freehold dwelling in the city centre. Basically, if one doesn't get a freehold house in the downtown core soon, it will be economically prohibitive for most Torontonians, just like other international centres. Here's a current article called Canada Faces House-Price Pickle Amid Push for Tighter Mortgages that offers more insights.
Today, if campaign promises ring true, then we will be shifting from an era of budget balancing to running a deficit in support of building infrastructure. To date, the government has been relying heavily on low interest rates from the Bank of Canada for economic stimulus. The theory now is that they’ll be able to stimulate the economy through their proposed infrastructure spending. As of this writing, the Bank of Canada is keeping its key interest rate unchanged as posted in this Globe and Mail article today titled Bank of Canada Stays On The Sidelines As U.S. Liftoff Looms.
More spending, of course, will require more revenue. Among the campaign promise offered to generate this revenue is increased tax on higher tax bracket earners, which by many analyst calculations will significantly detract from disposable income. In the same vein, those in the middle class will apparently expect some tax cuts - which should boost their disposable income.
This could potentially influence the market in a couple of ways: those who have been taking out more mortgage to land a coveted single family home may be more financially limited, which could potentially take a few players out of the pool - which could also result in less upward pressure in prices.
Another less obvious, but economically viable, factor that will likely present itself is an increase in government backed bonds to raise some of this needed revenue to fund Trudeau’s infrastructure. What do bonds have to do with real estate you may be asking? Potentially a lot.
Bond yields and interest rates have an inverse relationship - meaning that when rates are low, bond yields are higher (like in the current economy). If the government is on a push to generate capital, they will increase the issues of bonds - and then it comes down to supply and demand. More bonds on the market will dilute the yields; as the yields go down, interest rates go up. As analysts and think tanks have said repeatedly, even a small increase in interest rates could have significant (and in some cases dangerous ) impact on homeowners that are stretched thin, and on those who are looking to buy homes.
Here is a great article from Business Vancouver called “How The Liberal Win Will Affect Interest Rates,Taxes And Real Estate” that explains the bond scenario and the implications of the tax law revision.
Other potential politically-spun threats to the market? It’s not uncommon for an incoming government to blame items or situations that are not robust on the outgoing government, and that is likely what we can expect from the Trudeau government as it relates to the housing market. They are saying that the economy has seriously dwindled in the last few months of Harper’s government.
They are already downgrading forecasted economic growth, touting significant larger federal deficits, and are signaling a “larger than anticipated correction in residential (housing) investment.” The Parliamentary Budget Office expects growth to slow and interest rates to rise (perhaps as part of their tax revisions?) which will cause prices to pull back. They are counting on Canadians to continue to invest in housing as a key economic stimulus, and seem to be playing both sides of the coin in their predictions.
The PBO says in their outlook “Residential investment could continue to surprise on the upside and/or the speed of the adjustment to its fundamentals could be more gradual than expected.”
Here are some good articles that expand on that potential to soften the market: From the Globe and Mail “Liberals Inherit Deficit That Could Jeopardize Budget Goals” and from the Huffington Post “PBO's Economic Outlook Hands Trudeau Some Early Bad News On Economy, Deficit, Housing”.
Bill Morneau, Finance Minister
It’s not all doom and gloom for the housing market in the change of political promises. One of Trudeau’s campaign promises was to increase and/or alter the rules around the Home Buyers Plan, which allows first time homebuyers to withdraw from their RRSP for a home down payment. He may increase the maximum amount from $25,000 or possibly open the program up to home buyers of any kind, not just first timers. Here is an article about that and some other first time home buyer political promise perks called “Liberal Win Good For First Time Home Buyers”.
This could be a good thing, because it could potentially reduce the amount of debt you need to take out to buy the home you seek. However, it could backfire if people use it to bump up their budgets. We touch on the pros and cons of this in a recent Dear urbaneer post called “Dear Urbaneer: Should I Use My RRSP As A Down Payment?”
No matter how you slice it though, it is something to watch and to consider in the coming months, as some of these campaign promises get implemented.
The Question Of Affordability
One of the most prevalent and forceful elements that shapes the housing market- both in terms of economic and socio-economic impact is that of affordability.
As prices continue to climb in the city of Toronto at a rapid pace, the dream of homeownership begins to pull away from many. And it’s not just those who are trying to get into the market who are feeling squeezed by these bounds of affordability; those who are trying to climb their way up the property ladder in the natural flow of housing evolution are finding that they are in a predicament. Due to a lack of supply in freehold downtown housing and subsequent price hikes, many homeowners either have to stay put - or make huge leaps up the ladder - stretching themselves to the maximum edges of their budgets just to get into that segment.
High Debt Load, High Anxiety?
If the market pulls back (as many are indicating that it will, at least moderately) in the coming months, it could be significant - and dangerous for those who are already vulnerable because of high debt loads. What is at stake here is not just a downgrade in property prices, but the net worth of those who are over leveraged with debt would suffer a serious blow.
A new report released by the Canadian Centre for Policy Alternatives highlights the incredible vulnerability of young homeowners (and those who are saddled with housing debt) in the face of even a moderate correction. It says that it the event of a 20 percent market correction,1 in 10 heavily indebted homeowners will find themselves owing more than they own. Obviously, all homeowners will feel the effects of a market correction, but as this report points out, the impacts on the heavily indebted homeowner is disproportionately negative.
Should this shift occur, the negative effects of high debt loads against shrinking assets will cascade throughout the rest of the finances. Here is an article from the CBC called “20% Housing Correction Would Push Young Homeowners Under Water” which highlights the findings from the report.
The report goes on to talk about the high debt-to-ratio incomes in hot property markets like Toronto. The debt-to-income ratio for people in their thirties has skyrocket to 4 to 1 - which has nearly doubled in the last 15 years - and is by far the largest ratio among age groups. Alongside this high ratio is a market with a false sense of strength, due in part to the influx of new condominiums, which have been mostly absorbed by foreign investors lured by the falling loonie.
Furthermore, this extended period of low interest rates has done well to stimulate the economy - and has enabled many Canadian consumers to borrow more to buy more (as is commonplace in the Toronto property market), but studies suggest that many Canadians are reaching their debt thresholds. Spending will have to slow, which could soften the market as well. A new report from payment solutions provider Moneris showed that Canadian debt spending increased nearly 7 percent last quarter, which rounds out a full year of increases.
Here is a good article from the Huffington Post called “Here’s Evidence That Canadians Are On A Debt-Fueled Spending Spree” that talks about consumer activity, and how tapped out homeowners and declining affordability will contribute to a pullback in the housing market.
Despite rising debt, consumers are still overspending, which a positive sign for retailers and the holiday shopping season
Although there is an appetite for debt in Canada, in cities like Toronto, it’s just a means to an end when you are trying to buy the house you want. Pushing this debt-to-income ratio in large part is the housing price-to-income ratio, which continues to proliferate, well out of whack.
Toronto’s price-to-income ratio is 8.2. To put this in context, for homes to be affordable in Toronto based on the median income, the average house price would be $228,657. The price-to-income ratio is determined by multiplying the average income by 3.
As we are well aware, the average price in Toronto is way, way more than $228,657. What this is doing in effect is creating a divide between the haves and the have nots, housing-wise. Here is an article from the Globe and Mail called “A House For Three Times Your Income? Think Again”.
Even the most recent statistics support the notion that this price-to-income ratio is way out of whack. In a rare move, TREB and BILD together issued a press release highlighting the significant impact that the lack of single family housing is having not only on shaping the dynamics of the market, but is creating this alternate sense of housing reality (or unreality as the case may be). In particular, they highlight what the average income should be to "comfortably" afford a home. In October, the average price in the GTA for a single family detached home was $962,312. With a 20% down payment, your income would need to be $174,854. According to Stats Can, the average income in Toronto is just over $107,000. That's quite a gap to fill, especially when you're taking on debt to do it. Click here to read TREB and BILD's release.
As the market continues to churn on, it always makes sense to pause and reflect - not just on where it is going, but where it has been in the last several years. It’s prudent to consider the possibilities and the vulnerabilities, in order to best position yourself as a Buyer or Seller in this dynamic, swiftly moving, emotionally charged market.
Do you need help applying your own personal context to all of the factors that exist around the market? At Urbaneer, we have decades of navigating the real estate market. In addition to our own experience, we spend hours on a regular basis connecting with media reports and data-based information to help shape our own insights and advice. Could we help you on your house hunt, sell your home for top dollar or strategize your position on the property ladder? Please know we're here to help!
Did you miss Part One? Here's Urbaneer’s Winter 2015 Toronto Real Estate Forecast: Part One!
~ Steven and the urbaneer team
earn you trust, then your business
Steven Fudge, Sales Representative
& The Innovative Urbaneer Team
Bosley Real Estate Ltd., Brokerage - (416) 322-8000
Like what you've read? Consider signing up in the box below to receive our FREE monthly e-newsletter on housing, culture and design including our love for unique urban homes and other Toronto real estate!
Love Canadian Housing? Check out Steve's Student Mentorship site called Houseporn.ca which focuses on architecture, landscape, design, product and real estate in Canada!