Flaherty’s New Mort­gage Rules A Scape­goat For A Much Big­ger Problem

Daniel Tencer – Huff­in­g­ton Post

This sum­mer, Prime Min­is­ter Stephen Harper and Finance Min­is­ter Jim Fla­herty took a reg­u­la­tory ham­mer to Canada’s hous­ing mar­kets, caus­ing condo sales to plum­met in Toronto, and sink­ing Van­cou­ver house prices by jaw-dropping margins.

Com­ment: No, Van­cou­ver only dropped 0.8% accord­ing to Ter­anet. And that had noth­ing to do with mort­gage rules, they have been drop­ping by almost a third over the past cou­ple of years. And all Toronto real estate sales have slowed, by an aver­age of 14% lower in each of the 4 months fol­low­ing the new mort­gage rules. Exactly in the mid­dle of the 11% to 17% of buy­ers who would not qual­ify under the new rules, accord­ing to CAAMP. Amaz­ing how much those num­bers mesh and how exact the tim­ing of the sales drop was.

Or so the finance and real estate indus­tries would have you believe.

Com­ment: Or the actual data, the facts. They get in the way of so many great argu­ments, I know…

To hear Canada’s banks, indus­try groups and even the Con­fer­ence Board tell it, the slow­down that descended on many Cana­dian hous­ing mar­kets over the sum­mer is the fault of the strict new mort­gage rules Fla­herty put into place this past June.

Com­ment: Actu­ally the new rules came into effect in July… you didn’t even get the tim­ing right. And yet we went from 1.5% fewer sales in July to 12.5% fewer in August to 21% fewer in Sep­tem­ber. May had 11% more sales than in 2011. What changed from May to Sep­tem­ber – oh right, new mort­gage rules that dis­qual­ify up to 17% of home buy­ers. All num­bers for Toronto, I am not com­ment­ing on national figures.

“To the sur­prise of no one, fol­low­ing the intro­duc­tion of the most recent rule changes, sales activ­ity ratch­eted down,” said Gre­gory Klump, chief econ­o­mist at the Cana­dian Real Estate Asso­ci­a­tion, in announc­ing a 15.1% year-on-year decline in home sales for September.

Com­ment: And they were down 8.9% in August, after being up up 3.3% in July. So changed almost 20% and went from ris­ing sales vol­ume to neg­a­tive sales vol­ume with new mort­gage changes right in the mid­dle. Vol­ume up 3.3% in the month of changes, down 8.9% in the month fol­low­ing. And we want to say that the new mort­gage rules were not the cause?

The Toronto Real Estate Board chimed in: “Some house­holds have put their home pur­chase plans on hold in response to the higher cost of home own­er­ship brought about by the recent changes to mort­gage lend­ing guidelines.”

Com­ment: Of course they did. If they can’t buy now, most peo­ple wait and save up a larger down pay­ment. Watch, spring is going to be crazy as all those who put their plans on hold come out and start buy­ing again.

The indus­try has good rea­son to main­tain this nar­ra­tive. For one, it makes it seem like falling sales vol­umes and prices are all “part of the plan,” noth­ing to worry about. (Not true.) And it also deflects uncom­fort­able ques­tions about the role of real estate devel­op­ers, agents, banks and indus­try groups in cre­at­ing the inflated house prices Canada has seen in recent years.

Com­ment: No one ever said it was part of any plan, only that the new mort­gage rules had an effect on sales vol­ume. And the only peo­ple who cre­ate prices are the 200,000 buy­ers and sell­ers involved in the 100,000 Toronto trans­ac­tions in 2011. Buy­ers are the ones will­ing to pay the prices, sell­ers are the ones demand­ing them. Devel­op­ers are respon­si­ble for maybe 15% of the mar­ket, so they cer­tainly can­not push prices too high. And when they sell 90% of a project, obvi­ously the 100s of buy­ers do not think the prices are inflated. They are buy­ing the units, they are pay­ing the prices. So who is to blame there? Who is to blame when 14 trendy fam­i­lies get in an all out bid­ding fist fight for a house near the lat­est Toronto Life “hot neigh­bour­hood” and bid it from $599,000 to $843,000? Is it my fault, as a real estate agent, or the fault of the buy­ers who HAD TO HAVE that house? Do you blame the seller, know­ing they have a valu­able prop­erty, squeez­ing every last penny out of it? You would too, you all know you would.

The media are happy to go along with it, because it offers a neat and sim­ple expla­na­tion for why Canada’s decade-long hous­ing boom is com­ing to a halt. The only prob­lem is, this isn’t what’s happening.

Com­ment: What? The media paints real estate agents as the devil, slightly below lawyers and used car sales­men. We are all in in for the money (isn’t that why we all go to work?), we are push­ing prices up, etc. How about the banks and their low rates? Oh wait, that comes indi­rectly from the Bank of Canada – do we blame them? Oh wait, low rates mean slow econ­omy, a result of the Euro woes – do we blame Greece or Spain? Wait, how about bash­ing all those ter­ri­ble immi­grants, all those hor­ri­ble peo­ple who want to escape their home coun­tries to come to Canada – they all need a place to live. Shall we blame them for want­ing to live in our won­der­ful coun­try? Let’s put the blame where it is due!

First the back­ground: Fla­herty tight­ened the rules for mort­gages for the fourth time in as many years this past June, reduc­ing the max­i­mum length of a mort­gage insured by the CMHC to 25 years from 30, effec­tively mak­ing that the max­i­mum amor­ti­za­tion period for most Cana­di­ans who take out mort­gages. He also reduced the max­i­mum amount you can bor­row against the value of your house to 80% from 85%. These changes, like the pre­vi­ous ones, were aimed at ensur­ing that Canada’s ris­ing home prices weren’t due to irre­spon­si­ble lend­ing and borrowing.

The be sure, this will have a cool­ing effect on the hous­ing mar­ket. There are prospec­tive home buy­ers who just can’t afford the extra $140 per month, on aver­age, that the shorter mort­gage peri­ods rep­re­sent. Some home­buy­ers have just been priced out of the mar­ket. But can that alone explain the 70-per-cent drop in condo sales in Toronto, or the nine-per-cent drop in house prices in Vancouver?

Com­ment: Actu­ally, if we take the aver­age semi-detached in Toronto priced at $583,117 the change with 5% down on a 3.09% mort­gage is about $294, $374 on the aver­age detached house. It is cer­tainly not $140. And for those stretched to buy, an extra $100 a week is not chump change. Not if you have kids and could be spend­ing $1,500/month on day­care. And that mort­gage on the detached house is $3,817. Add in util­i­ties, prop­erty tax, car pay­ments and oh… food… and it is a lot of money per month. That extra can mean a lot. And it obvi­ously did mean a lot, as sales vol­ume fell as soon as the new rules came into effect.

Highly unlikely. TD Bank fore­cast the impact of the mort­gage rule changes on the hous­ing mar­ket and found it would amount to a three% decrease in house prices — far less than what Van­cou­ver, for one, has already seen. Not to men­tion, we’ve had three pre­vi­ous rounds of mort­gage rule tight­en­ing since 2008, and none of them tipped the mar­ket down­ward. Clearly, some­thing else is hap­pen­ing here.

Com­ment: No, the three pre­vi­ous rule changes did not really affect peo­ple. This one did. Pre­vi­ous changes affect for­eign investors and re-financers mainly. The amor­ti­za­tion changes from 40 years to 35 to 30 did not do too much.

The hous­ing market’s fun­da­men­tals aren’t look­ing good. Stand­ing in the way is that pesky basic law of eco­nom­ics — sup­ply and demand. In some Cana­dian mar­kets, those two things have become entirely detached from one another.

Com­ment: Except Toronto where we have 100,000 peo­ple mov­ing here every year with only 25,000 new hous­ing units being cre­ated. Even con­ser­v­a­tive esti­mates of 30,000 new house­holds being cre­ated (I think it is closer to 50,000) still have us shy by at 5,000 hous­ing units. Add to that divorcees need­ing two homes now, chil­dren mov­ing out of the parental home, uni­ver­sity grads, etc. and there is a steady and press­ing demand here in Toronto. That is why 170+ condo devel­op­ments can sell 80–90% so easily.

As the CEOs of both BMO and RBC have attested, Canada’s real estate mar­ket is sim­ply over­built — par­tic­u­larly in Toronto, where condo con­struc­tion has grown so thor­oughly out of hand that there are now twice as many high-rises going up there as there are in New York City.

Com­ment: And yet they are all being bought, with 20–25% cash down. The demand is there, that is why there is the sup­ply. There are no new rental build­ings being built, con­dos are the new rental mar­ket. And our vacancy rate is 1.4% which is incred­i­bly low – which means bid­ding wars on rentals now. I have heard of 45 peo­ple show­ing up for a mass show­ing of a sim­ple one-bedroom loft. That, my friend, is what we call demand.

And more, much more, con­struc­tion is being planned.

In Van­cou­ver, where res­i­den­tial con­struc­tion has been some­what more restrained than in Toronto in recent years, the supply-demand dis­con­nect is reflected in prices, which have flown so high that Van­cou­ver has nearly as many houses listed for sale over $1 mil­lion as sell in the entire United States in a month. The city’s hous­ing costs ranked as the sec­ond least afford­able in the world, after Hong Kong, in a recent survey.

Com­ment: In the US I can buy some entire towns for less than $1 mil­lion. Have you been there recently? The land is worth­less… Check out Buf­falo or Detroit or Rochester or Gary, Indi­ana. Whole swaths of the coun­try are aban­doned and derelict because it is not even worth tear­ing the build­ings down.

Across the coun­try, house prices are now 35% higher rel­a­tive to income than has been the long-term trend through his­tory, Bank of Canada Gov­er­nor Mark Car­ney noted ear­lier this year.

Com­ment: But the car­ry­ing costs are way lower. The aver­age price in Toronto last month was $485,000. At today’s best rate of 2.89% with 20% down the mort­gage is $2,191. Back in Novem­ber 1981 when mort­gage rates were 18.8% and house prices were only $90,203 the mort­gage pay­ment with 20% down would have been $1,470 – in 1981 dol­lars. Adjust for infla­tion (using the Bank of Canada infla­tion cal­cu­la­tor) and that mort­gage pay­ment is actu­ally be $3,508 in 2012 dol­lars. So your price-to-income ratio is moot. It is the actual monthly cost that mat­ters and monthly mort­gage costs are at a his­tor­i­cal low. Just look at the recent RBC report.

Sim­ply put, prices are too high. Cana­di­ans aren’t earn­ing enough to jus­tify these price lev­els. And closely linked to this is the ele­phant in the room: debt.

Com­ment: But that fact alone does not mean any­thing. Prices are high for a lot of things: houses, dia­monds and Porsches. It does not mean they have to come down. Real estate prices are higher in New York, even higher in Lon­don and even higher in Tokyo. So what?

It has never been cheaper to take on debt in Canada. With a global finan­cial cri­sis bust­ing out all around, the Bank of Canada dropped its base inter­est rate to one% in Jan­u­ary, 2009, and it has stayed at or below that level for nearly four years now.

Com­ment: Debt is a whole other issue, I give you that. It is the debt used to finance vaca­tions and TVs, the kind of debt with noth­ing to show for it, that is dan­ger­ous. Hous­ing debt is good debt, you have a large and tan­gi­ble and valu­able asset. A TV is worth­less the day after you buy it and a vaca­tion is just burn­ing money. And that kind of reck­less spend­ing could cer­tainly get us all in a lot of trouble.

Some econ­o­mists argue this is an exces­sively expan­sion­ary pol­icy that has over­heated Canada’s hous­ing mar­ket. (Plenty of oth­ers would say that, given the dam­age tak­ing place in other parts of the econ­omy, those low rates were necessary.)

All this has had an alarm­ing effect on house­hold bal­ance sheets. StatsCan recently revised its mea­sure­ment of house­hold debt to make it more in line with inter­na­tional norms, and found the debt-to-income ratio hov­er­ing at a record 163.4%, higher than the level the U.S. had when its hous­ing mar­ket began a years-long decline half a decade ago.

Com­ment: But we can­not com­pare the new num­bers with the old num­bers since we are using dif­fer­ent meth­ods of mea­sure­ment. When we used the same mea­sur­ing stick, our cur­rent debt was around the same level as the US. Not that it mat­ters, their sit­u­a­tion was so far dif­fer­ent from ours that we might as well be com­par­ing real estate on Mars.

That offers more of a clue to why Canada’s hous­ing mar­ket has peaked and appears to be on a down­ward tra­jec­tory. It’s basic math­e­mat­ics writ small in the finances of house­holds across the coun­try — there’s just no more breath­ing room to bor­row more money.

Com­ment: Huh? Your made-up down­ward trend is because we have too much debt and can’t bor­row more, even though you argue that money is too easy to bor­row? What?

Add to that the phe­nom­e­non of for­eign investors bail­ing on con­dos, at least in Toronto, and you have a pretty per­fect storm for a hous­ing slowdown.

Com­ment: WHAT? For­eign investors are not bail­ing on Toronto con­dos, there is NO evi­dence for that at all! That is pure spec­u­la­tion, I could call it a fab­ri­ca­tion or worse. There is no data on for­eign investors, none. About all we have is Tridel say­ing 5% of their buy­ers are not Cana­dian cit­i­zens and a mort­gage group say­ing they have 4% for­eign buy­ers on their books. Even if they all stop buy­ing tomor­row, which they won’t, it does not impact 95% of the condo mar­ket. So take your fake stats and… never mind, bet­ter to be polite.

And, if any­thing, the adjust­ments to the mort­gage rules were too lit­tle, too late.

What should hap­pen in a mar­ket like this is a re-balancing — or a cor­rec­tion, if you pre­fer. What­ever the ter­mi­nol­ogy, house prices have to come down rel­a­tive to incomes. Then and only then can they return to healthy, sta­ble lev­els of growth.

Com­ment: No, they don’t. What about NYC where rents aver­age $3,400 a month? And real estate approaches $1,000/sf to start. Do New York­ers make twice as much as Toron­to­ni­ans? Nope… If inter­est rates rise, then we might see prices flat­ten­ing or drop­ping. A jump from 3% to 5% would push monthly costs up around $510 on the Toronto aver­age $485,000 prop­erty. That would cer­tainly hurt. Espe­cially when added to the $300 extra the amor­ti­za­tion drop caused. Add $800/month to the aver­age prop­erty over the course of a few years and you can cer­tainly see where some down­ward pres­sure would come from. Or, prices would sim­ply sta­bi­lize while vol­ume fell to more his­toric val­ues in the 50–70,000 annual trans­ac­tions range. Heck, for most of the  20 years before the 2000s we had around 30–60,000 trans­ac­tions a year. And prices rose in all but 4 of those years, regard­less of whether there were more or less sales than the year before. Prices have risen in 43 of the past 47 years (includ­ing 2012) even with mort­gage rates push­ing 20%, even when rates dou­bled from from 1978 to 1981 (10.67% to 21.46% in 48 months), prices still rose ($67,333 to $90,203). Prices rise, it is called infla­tion. Remem­ber Grampa telling you about movies for a nickel? Try explain­ing that to Cine­plex when they ask $19.95 to see Bat­man – I don’t think that logic will work on them. When I was a kid, choco­late bars were $0.43 with tax – now they are 2 for $2.22 + HST. Lis­ten to old Bill Cosby standup, back when he talks about is $19,000 Rolls Royce – which he bought new. Hous­ing prices may expe­ri­ence some minor ups and downs, but they will always rise over time.

Our finance min­is­ter agrees with this.

“It’s bet­ter to have some soft­en­ing in the mar­ket rather than have sud­den move­ment,” Fla­herty said this sum­mer, talk­ing about the new mort­gage rules.

But can “soft­en­ing” be achieved at this point? Or has the hous­ing mar­ket become so out of bal­ance that there’s sim­ply no way to avoid a hard land­ing? That, of course, is the big ques­tion these days.

Com­ment: Only amongst the media, the pun­dits and the wags. Any­one who looks at the avail­able infor­ma­tion knows what is going on. None of us can pre­dict the future, but with enough data we can form an intel­li­gent opin­ion. Or, we can shout bad news from the rooftops, a lot of peo­ple pre­fer that option.

Yet how­ever you slice it, this is one phe­nom­e­non that you can’t pin on last-minute reg­u­la­tory changes. So blame it on exces­sive debt. Blame it on over-enthusiastic real­tors, or home­buy­ers who have finally drawn a line in the sand on house prices.

Com­ment: Yes, you can. I have proven it over and over through­out this piece.

Just don’t blame it on Harper and Fla­herty. All they did was close the barn doors after the horses had fled, and help the chick­ens come home to roost.

Com­ment: It is not a mat­ter of blame, it is a mat­ter of cause and effect. We can all see the effect and the cause is no less obvious.

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Con­tact the Jef­frey Team for more infor­ma­tion – 416−388−1960

Lau­rin & Natalie Jef­frey are Toronto Real­tors with Cen­tury 21 Regal Realty.
They did not write these arti­cles, they just repro­duce them here for peo­ple
who are inter­ested in Toronto real estate. They do not work for any builders.
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should I buy Toronto real estate 2013

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