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Are these the first signs of a housing crash?

Some housing markets have slowed amid rising interest rates and new mortgage rules

Since 2000, home prices increased 240% across Canada—with the price of homes in Vancouver and Toronto leading the pack.

After this long period of huge gains, house prices have started to cool. At 2.9%, the annual increase in prices in 2018 was way below the 13.3% increase in 2017. Factors such as rising interest rates and new mortgage rules are having an impact.

Are these the first signs of a housing crash? What will happen in 2019? This article looks into the reasons behind the surge in home prices and provides insights into the future direction of housing prices.

What drove the boom in house prices?

Immigration and housing demand—Canada’s population is currently growing at a faster pace than it did in the last decade. Since the 1990s immigration has accounted for about two-thirds of population growth. The recent trend has been even stronger, with net migration accounting for 80% of population growth this decade.

Research by Statistics Canada and the Canada Mortgage and Housing Corporation also indicates that immigrants may have a stronger preference for investments in housing than Canadian-born citizens. The average value of single-detached houses owned by immigrants in Vancouver is 17% higher than that of comparable houses owned by people born in Canada.

Low interest rates—In the aftermath of the last financial crisis, the Bank of Canada reduced its trend-setting interest rate to 0.25%—the lowest ever seen in Canada. Low interest rates enabled home buyers to purchase more expensive properties.

More condos are being built than single-family homes—The construction of multi-dwelling units has outpaced single-family housing nationally since 2006. The trend began much earlier in the major cities—since the early 1990s in Vancouver and the early 2000s in Toronto. This has created a shortage in available single-family homes, resulting in strong upward price movement for these homes.

In some cities, other issues, such as zoning by-laws (density requirements, green belts) and geography, have limited the supply of housing and helped drive prices up.

The market cooled in 2018

The run-up in prices took a break in 2018, when nominal house prices grew by only 2.9% and real prices rose by just 0.7%. Changes in mortgage rules and higher interest rates were behind the slowdown.

In the 1990s, mortgage guidelines were loosened to spur housing investment. They were relaxed further in 2006 when mortgage amortization periods increased from 25 to 40 years and loan-to-value (LTV) ratios increased from 95 to 100, meaning no down payment was required.

Following the financial crisis and recession of 2008-09, lending conditions tightened. Ultimately, the amortization period was cut back to 25 years and the LTV ratio for all houses was lowered back to 95 or more restrictive in some cases. Provincial policy measures targeting foreign buyers also hit the market. British Columbia has implemented a foreign buyers’ tax of 20% on homes in the Greater Vancouver area. Ontario followed suit and adopted a similar tax of 15% for homes in the Greater Toronto area.

The latest change came last year from the Office of the Superintendent of Financial Institutions. Its Rule B-20 requires regulated lenders to put potential borrowers through stress tests. This new mortgage rule reduces the amount Canadians can afford to borrow by around 20%, disqualifying about one in five potential buyers and shutting many young buyers out of the market, according to a Mortgage Professionals Canada survey. The new rule had an immediate tempering effect on the market.

Higher interest rates have put a further damper on the housing market. The Bank of Canada raised its rate by 0.75% in 2018, and by 1.25% since 2017.

Research shows it takes between three and five years for changes in central bank interest rates to fully work their way through the economy. When they do, a one percentage point change in interest rates can have a three-to-five percentage point impact on home prices. This means we can expect the increases in the bank’s policy rate in 2017 and 2018 to continue to dent housing prices in coming years.

The biggest risk to the housing market is high household debt

As housing prices have increased, banks have extended more credit to households, the majority of which has been mortgages (72%). As a result, the total household debt-to-income ratio has been on a relentless upward trend, reaching a record 174% in 2018.

Another worrisome trend is that household income growth has slowed down, even as interest payments have risen. This is showing up in a higher share of disposable income going to service debt—almost 15% as of the fourth quarter of 2018.

The vulnerability of households to a rising interest rate environment has become an increasing concern. Indeed, the Governor of the Bank of Canada estimates that the economy is 50% more sensitive to rate hikes than in the past. This could potentially force a significant number of households into a difficult financial position, triggering a broader slowdown in both the housing sector and the broader economy.

Is a crash coming?

We don’t think so. The economy is doing well. Job growth is strong, with the economy creating over 390,000 new jobs between December 2017 and 2018 and GDP regained lost ground in January (see our Canada article for more information).

As long as people continue to work, they will likely to be able to meet their debt repayments. Also, there were a number of measures announced in the federal budget designed to assist first-time home buyers.

The Bank of Canada’s pause in its hiking cycle for 2019 will also help.

What does it mean for entrepreneurs

  1. If your business operates in the housing or construction sectors, expect a mild slowdown. However, you probably don’t need to worry about a housing crash.
  2. For homeowners planning to sell, prepare for lower price gains than in the past, especially if you are located in Vancouver and Toronto.

 

Culled from Business Development Bank of Canada Newsletter-April 2019

Rent-To-Own Home. New Way to Home-Ownership

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Rent-To-Own (RTO) is an alternative arrangement for owning a property without outrightly committing huge cash towards the property. As the name implies, the arrangement allows the tenant committing to rent the property for over a period of time (like 2-3 years) and later buy it outrightly from the property owner when he or she is in a better position to raise the necessary funding.

Parties to RTO

Every Rent-To-Own usually comprises of the person who wants to rent a property now and later own it, (called Tenant-Buyer), the Home-Owner (Called, Property Owner), Real Estate Investor (Could be a Real Estate Broker or Agent, or an individual interested in real estate as an investment etc) and a Mortgage Lender.

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Bank of Canada raises interest rate to 1.75%

Central bank’s benchmark rate pushes up borrowing costs for consumers

The Bank of Canada, led by governor Stephen Poloz, has increased its benchmark interest rate five times since the summer of 2017. (Adrian Wyld/The Canadian Press)

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  • CIBC, TD, Royal Bank and BMO all hike their prime rates too

The Bank of Canada has raised its benchmark interest rate by a quarter point for the fifth time since last summer, pushing up the cost of borrowing for Canadians.

The bank’s rate is now set at 1.75 per cent. That’s the highest it’s been in almost a decade, dating back to December 2008.

Known as the target for the overnight rate, the benchmark is what Canada’s big banks charge each other for short-term loans. It filters down to consumers, because it affects the rates the banks offer their customers for things like variable rate mortgages and savings accounts.

That’s already happening, as four of Canada’s biggest banks increased their own prime rates by a quarter percentage point on Wednesday.

Royal Bank, TD, BMO and CIBC have all raised their prime lending rates from 3.70 to 3.95 per cent. Scotiabank is expected to follow suit soon, but all the new prime rates will be in effect as of Thursday morning.

Canada’s central bank has kept its interest rate at record lows for several years to stimulate the economy following the economic slowdown of 2008, but has since begun to ratchet it higher as the economy gets back on sounder footing.

(CBC)

Economists are expecting a few more rate hikes to come, but the bank hinted on Wednesday that it wants to see how current rates are affecting the economy before proceeding.

“In determining the appropriate pace of rate increases, [the bank] will continue to take into account how the economy is adjusting to higher interest rates, given the elevated level of household debt,” the bank said.

In explaining its decision to raise the rate, the bank noted the recently announced free trade deal with the United States and Mexico as a reason for optimism about Canada’s economy.

The bank also said it expects household spending to increase at “a healthy pace.”

“The reality is that the economy is at its capacity and is no longer needing stimulus,” central bank governor Stephen Poloz said at a news conference following the announcement. “And so it’s our job to prevent the thing from overheating and creating inflation pressures down the road.”

Economists expect more hikes

Candice Bangsund, a portfolio manager at investment firm Fiera Capital, interpreted the bank’s statement as a clear sign it has strong confidence in the outlook for the economy — which means rate hikes to come.

“The bank’s … upbeat tone in the statement is not all that surprising given that the economy is operating near full capacity and core inflation is hovering around target, while trade tensions have receded substantially following the successful renegotiation of NAFTA,” she said.

Winnipegger Michelle Kennedy has a fixed-rate loan, but is worried what rates will be when she has to renegotiate in three years time. (CBC)

Economist Brett House at Scotiabank agrees with that assessment, and said he thinks the bank likely won’t move to the sidelines until the rate gets to the “neutral” level of about three per cent.

“It says not only can you get more rate increases, but they’re probably going to happen on a more frequent basis then we’ve seen in the last year and a half,” House said.

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                                          RTO Programs
A B C
Minimum Down Payment on Purchase price 5% (or $10,000) 3% (or $18,000) $10,000
Minium Househould Income Depends on Property Price $95,000 $50,000
Stream of income Required Required Required
RTO Tenure 3-5 Years 2-3 Years 2-4 Years
Monthly Rent (include Savings for future additional down payment) Yes Yes Yes
Property Purchase Prices Pre-Agreed Pre-Agreed Pre-Agreed
 Credit Repair & Debt Settlement Available Paid Service Paid Service Free service
Location of Operation GTA Canada Wide Canada Wide
Initial Option Same as down payment
Monthly Option Same as Rent

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