Many people are mystified by why Canada's home prices are rising. Here are some possible explanations.
24th March, 2017
8th August, 2017
Massive change in purchasing power
In the 1970s you probably had to save 20% to buy your first home. Down payments were created to ensure buyers had equity in their homes even if the market experienced a downturn. Down payments also serve as a hurdle that limits your purchasing power and are entirely independent of interest rates.
In the late 90's CMHC grew its mortgage insurance business. This meant payments as low as 0%, but today it stands at 5%. As long as buyers were willing to borrow an extra ten thousand or so and hand it over to the federal government, they would be free from having to save the full down payment their parents had to. In places like the GTA, down payments are no longer a hurdle that are limiting home prices for first-time buyers.
Mortgages can now be maxed based on monthly cost which changes based on interest rates. At the same time as mortgage insurance became popular, the average mortgage rate fell from 9% in 1995 to 3% in 2015. These two factors provided a massive increase in purchasing power, especially for first-time buyers.
We pulled more demand forward for first-time buyers than move-up buyers. Move-up buyers generally don't use mortgage insurance and with age are more likely to be credit-adverse. This has helped to create a short-supply of first-time buyer housing stock.
Can you spot when the twenty year housing boom started in Canada by looking at this chart? Think about it next time when the Federal Government tells you they are not sure why home prices are rising. Between population growth, interest rates and mortgage insurance, they have the housing market completely cornered.
Population growth either through births or immigration creates future demand for housing. Canada controls its population and ensures it grows every year through immigration, versus other countries that are dependent on volatile birth rate. This stream of buyers ensures that there is a constant pressure on homes that never lets up.
More people mean new homes must be built, which in turn means all homes in that neighbourhood get priced relative to what those new homes cost to build plus their land value. Taxes, regulations and increased development infrastructure costs, combined with higher land prices, has significantly raised the cost of a new build homes and condos - especially in places like the Greater Toronto Area.
It has been reported that 10-year visas are commonly misused by wealthy investors in China and to a lesser extent India, as a mechanism to invest in Canadian real estate. There is significantly more 10-year visas issued every year then the immigration rate, and this is rising. If this investment demand continues it is likely to continue to price out first-time buyers from the market.
If you increase taxes and costs on new home developers, you will increase the price of all homes in your community if people choose to continue to live there and the population grows. Additional funding, communities centres, roads and parks all add up. HST, CMHC fees and many other taxes along the way. So why should all existing home owners profit personally from a tax that young, hard-done-by youth must pay just to get in to the market? It's a wealth transfer from the poor to the rich, something that historically would have been shunned in a progressive Canada.
First-time buyers are paying huge taxes that more wealthy existing home owners often did not have to pay when they entered the market. In a growing population home prices are heavily influenced by the cost to build a new home so there is no way for non-home owners to escape these taxes.
Communities should limit the burden of development costs, taxes and infrastructure on new home developers. For young buyers, they not only pay more to get into a home, they have to pay higher property taxes because the home price is inflated due to taxes. These development costs and taxes most hurt the poorer younger populations in Canada who do not currently own a home.
On the same note much of the infrastructure and what these taxes do pay for do add value to new home communities. So it's not a matter of eliminating the taxes but rather minimizing their impact on home prices especially for first-time buyers.
Increased non-financial regulations
We are limiting supply through regulations like intensification plans at a time when all these other stimulative factors are at play. There is still significant demand for detached and low-rise homes, but supply of new lots has been restricted. Rezoning plans can be completed faster to increase the supply of serviced lots.
So why do we intensify? We have cities preferring high-rise as the tax per acre is the highest while the costs per acre are the lowest. Unfortunately they might not tax you any differently. Condo owners should be arguing for lower property taxes as they are currently subsidizing other communities.
Larger better cities with more foreign demand
Toronto and Vancouver are growing. They've reached a size where it has become difficult to find low-rise land available within driving distance. This means intensification, which of course drives land values up. Foreign buyers have become more popular and thanks to their wealth and the exchange rate, are less sensitive to marginal home prices. This lack of sensitivity helps set higher prices.
When home prices rise fast and all these other factors are at play, you are going to attract speculators. A speculator is someone who has no intention of holding the asset in the long term but create additional short-term demand. They may make up just 10% of the market, but when demand is already high, that is the difference between warm and boiling hot.
Singles / One parent households
Since the 1970s to today, we've moved from a 3.5 person household to a 2.5 person household. This means more homes for the same population and less dependants per household.
Average investment returns are low post-Global Financial Crisis. So you can hold land as part of your portfolio without missing too much opportunity elsewhere. In fact negative interest rates mean that in some markets you are charged to hold deposited cash or low-risk bonds, so investors are encouraged to buy and hold land versus developing it. If the province and federal government continue to create investment security by staying committed to transparent long-term growth plans, it makes sense for some to hold land to maximize return.
Low interest rates cause assets to rise because the cost to hold them decreases thus lowering supply. Low interest rates also make assets that are purchased with credit far more affordable so demand increases. It's these two factors that create the obvious rise in asset prices.
High interest rates means assets have to be put to productive use soon or else sold to someone else who will use them, as either monthly expenses are higher for borrowers or the opportunity cost to hold is higher for the wealthy.
This is a market function that is fairly obvious to most, but you have to question whether central bankers really understand this or that in fact they do, but they ignore it in an effort to keep the dollar low and drive inflation. Low interest rates hurt the economy in one sense because it can cause assets to be hoarded and used less productively - which can reduce growth potential, and thus cause a cycle of justifying lower interest rates. In the long-run this can make the economy sick by misallocating resources, and can also create financial risks when assets are repriced when rates rise.
In a healthy market, lower interest rates might have meant that rents fell as the cost of capital for landlords decreased. You can imagine this would be the case with commodities. However a combination of tight-supply due to population growth and that new builds are not necessarily subject to rent control in places like Ontario, has meant that rents have increased and are out of control in some downtown markets.
First-time buyers need to be protected. We at NewHomeFinder are committed to promoting a healthy new housing market that is attractive for both builders and new home buyers. Today it feels like we sold the future of our children away to the highest bidder. The nature of politicians to take easy steps to increase personal balance sheets directly via interest rates, versus growing the household income statement which in turn grows the balance sheet. The latter of course is the best way to grow the economy over the medium and long-term.
Our youth are the most important group in our country - this diverse group is our future and they are totally dependent on us giving them the best possible chance. People have immigrated to Canada from around the world to give their families the best chance of success. However it is only a matter of time before the fundamentals in the younger age group deteriorates as non-household income has only grown 40% since 2000 and household income has risen 54%. Certainly their largest costs including housing, taxes, food and energy have risen far far more than that. Debt has been used to finance the gap up to now, but that is not sustainable.
In capitalism, most of profits are created through reducing expenses while increasing revenue. Employees evaluate profit from the effort required and the amount of hours it takes to earn it. The fact that in Canada incomes are not rising and expenses are soaring should indicate that the economy is not moving forward, but falling way behind. This puts us in a very vulnerable situation if there is an economic shock - which occurs generally once a decade.
The good news is that there is a solution for everyone. Grow incomes. Either through improved productivity, innovation and aggressive international sales, we can grow the economy significantly more than how it has been performing. Government needs to be more efficient and innovative as well. It needs to become a responsibility that Canadians carry with them. It's not easy, but other countries have done it in the past. It takes leadership and a mindset. Canada has to believe it can do it, and refuse to sit in a state of Global Financial Crisis defeat.
For official or specific information, please refer to Canada Mortgage and Housing Corporation, Statistics Canada and the Government of Ontario.