Bank economists are not a wild bunch. Whatever the economic weather, they steadfastly resist undue excitement. The exclamation point on their keyboards goes unused.
So it has been notable to watch the rising alarm – yes, alarm – over Canada’s housing market from a procession of big bank economists. One of the first major calls of concern came in late February, after Bank of Canada Governor Tiff Macklem said that despite “some early signs of excess exuberance,” the market was a “long way” from the mania of 2016-17. Economists at National Bank disagreed and pointed to flashing red lights: price surges more widespread than ever across Canada and, compared with 2017, more vulnerable borrowers with high-debt, uninsured mortgages.
A Royal Bank economist in late March wrote that the housing market hasn’t had an “overheating of this scope since the late 1980s” and said it called for “a policy response.” A few days later, Bank of Montreal economists described Canada as living through a “housing fire” that “needs a response,” and argued “policymakers need to act immediately.”
This page, in February and again in March, called on Finance Minister Chrystia Freeland to take action. Last time around, in 2016-17, several provinces, cities and Ottawa did just that, bringing in new taxes in some areas and tighter mortgage rules nationwide. This time around, there’s been silence. Meanwhile, the average national sales price, according to the Canadian Real Estate Association, rocketed 25 per cent higher in February compared with a year ago – a massive gain that lands on top of two decades of outsized increases.
What’s happening today is strong demand – powered by ultralow interest rates, Canadians hungry to buy and a market psychology of buyers desperate to get ahead of rising prices by buying ASAP – smashing up against a low supply of homes for sale. In this unhinged market, there are many dangers, from overindebted buyers to a broader economy that is overreliant on real estate and would be shaken by a sudden fall in prices or jump in interest rates.
There are two principal policy actions: immediate rule changes and longer-term rethinking.
Let’s start with the long term. In Canada’s cities, zoning rules artificially constrict housing supply. Cities and suburbs are dominated by areas zoned for single-family homes. It’s a waste of space. Or in economists’ parlance, an inefficient use of land. Building modest, four-storey apartment buildings is impossible on most of the land in most municipalities. The Toronto Regional Real Estate Board says as many as 400,000 units could be added in Toronto if rigid zoning rules were modernized.
But the current market dangers also demand an immediate response. BMO pointed to “prices going parabolic,” with the market getting wilder by the day. “The action needed today is one that immediately breaks market psychology and the belief that prices will only rise farther,” the bank economists said.
The bank analyzed potential high-impact moves. Raising interest rates would work – but the Bank of Canada obviously isn’t going to slow the economy, and create more unemployment, to cool housing. Changes to the real estate bidding process could help, and are easy to implement, with little risk of hurting other areas of the economy. There is the political third rail of Canadian homes being exempt from capital gains taxes. Canada also has a brief history of using targeted capital gains taxes, such as one Ontario implemented in 1974 and kept for a few years, which taxed investors in housing but exempted principal residences.
Other measures that have recently been debated likely would have a low impact, according to BMO, such as tighter mortgage standards or reducing the equity Canadians can borrow against their homes.
Housing is a free market at the point of sale, but before that it is laden with rules, starting with constraints on supply. There is clamouring demand for roomier housing in multiunit buildings in Canada’s cities, but zoning makes it difficult for such housing to be built. With supply restricted, prices become skewed, lately grotesquely so.
Grappling with all of this will be a multidecade challenge. But cooling the present mania is the immediate order of business. Ottawa has to break a market psychology that has buyers and sellers both convinced that high prices today will only go higher – much higher – tomorrow.
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