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Outlook 2018, Part 3: You (still) can’t afford it: Housing, mortgages and Canada’s banks
Michael Babad

This article was published more than 6 years ago. Some information may no longer be current.

Briefing highlights

  • Economists see soft landing
  • Housing projected to cool
  • Interest rates forecast to rise
  • ‘Added uncertainty’ for banks
  • Markets at a glance
  • What to watch for in Fed minutes
  • BlackBerry in driverless car deal
  • EU clearing houses get MiFID reprieve

Many Canadians couldn't afford to buy a home last year. More won't be able to afford one this year. And many of us arguably can't afford the ones we've got.

That's the state of at least some of the housing markets in Canada, where prices are starting 2018 at just about double the levels of the crisis era.

Which shows you what Canadians have been doing for the past many years: We've borrowed heavily amid emergency low interest rates to bury ourselves in debt and drive home prices ever higher., to the point where we wonder if our kids will ever own a home.

This is the year of the writing on the wall as interest rates rise and new rules from the Office of the Superintendent of Financial Institutions, the commercial bank regulator, make it harder to get a mortgage.

This, in turn, will ripple through the economy, from consumer spending to bank lending.

"Real estate in Canada has been on a tear in the last few years," National Bank of Canada economists said in a recent report.

"Prices have almost doubled since 2009 and starts have averaged nearly 200,000 annually over the last five years," they added.

"Over all, the importance of housing in the economy as a whole has also increased, leaving the country more exposed to a housing shock."

Such a shock isn't in the forecasts of economists, though the risks are there. And they do expect a pullback in the market.

Still, as Bank of Montreal chief economist Douglas Porter put it, "Canada's housing market has defied the incessant talk of its imminent demise for years."

Here's how things stand at the beginning of a year that promises to be a crucial one for every industry with a hand in residential real estate:

Market stability

Economists generally see a soft landing, as opposed to a meltdown, but they also wonder whether the key Greater Toronto Area will follow Vancouver's example, with its government-induced slowdown being only short-lived.

And they're casting their eyes further afield, from Vancouver and Toronto to cities such as Montreal and Ottawa.

Certainly, last year was "mostly the story of Ontario - and more precisely, the Greater Toronto Area and nearby cities," as RBC senior economist Robert Hogue put it.

"Frenzied bidding wars were commonplace. Market dynamics were perverse: The more prices rose, the more buyers came in (afraid of being priced out) and sellers stayed out (earning a good return by just waiting). Prices skyrocketed by 30 per cent year over year, which clearly threatened the stability of the market."

But that was then. Now we have Ontario's Fair Housing Plan, which, among other things, borrowed from the B.C. government with a tax on foreign speculators.

This appears to have worked, for now, at least.

"In just a few months, the GTA market was back in balance," Mr. Hogue said.

"Sanity returned. Prices began to moderate. A modest rebound in activity since August tells us that the market isn't in a death spiral. It's been a healthy correction."

Sales and prices

We start 2018 with the new OSFI mortgage rules, the promise of higher rates and whatever impact lingers from the attempts of the B.C. and Ontario governments to tame the Vancouver and Toronto area markets.

There are many forecasts, and they differ, but all call for something slower.

The Canadian Real Estate Association projects a 5.3-per-cent drop in sales, to just shy of 499,000 homes, and a decline of 1.4 per cent in the national average price, though that would be skewed by the "record number of higher-priced" houses in Toronto last year that we won't see again in 2018.

Prices in Ontario, the group said, will fall 2.2 per cent, but will hold the line in British Columbia.

RBC, in turn, projects sales will slide 4 per cent, but benchmark prices will rise 2.2 per cent, a markedly slower pace than in 2017 but growth, nonetheless.

Toronto-Dominion Bank expects price growth to almost flat-line, also with no contraction.

Matthew Stewart, in turn, director of national forecasting at The Conference Board of Canada, expects the national average resale price to fall for the first time since the recession, but only by about 1 per cent and pretty close to the CREA forecast.

"The trend to a general cooling in the housing market will continue in the medium term, due to slowing household formation, moderating employment growth, and higher interest rates," he said.

And here's the bottom line, from a forecast by RBC economists: "The risk of a full-blown housing market crash occurring in 2018 is low, in our opinion. The majority of housing markets are in balanced condition and expected to remain so in 2018. This will maintain some degree of support for home prices, which are forecast to rise again in 2018, albeit at a considerably slower pace."

Affordability

Obviously, noted National Bank, the impact of rising interest rates will vary between cities.

"In some markets, notably Vancouver and Toronto, a rate hike could prevent new buyers from entering the market, putting home prices under pressure," the bank said.

"Consider the effect on new buyers of a one-point increase in mortgage rates in those cities. Twenty years ago such a hike would have increased the burden of debt service by 4 per cent of median income. Today the hit would be twice that."

In their latest look, RBC's Mr. Hogue and his colleague Craig Wright, the bank's chief economist, found affordability in Vancouver, Toronto and Victoria at the worst levels ever in the third quarter of 2017, with "tensions rising" in Ottawa and Montreal, though not yet out of hand.

Just look at what's happened since the crisis, based on how RBC measures affordability:

Rising interest rates will bring with them "serious implications" on that front this year, Mr. Hogue and Mr. Wright warned.

"We estimate that, everything else remaining constant, a 75-basis-point increase in mortgage rates would lift RBC's aggregate measure for Canada by approximately 2.5 percentage points," they said in their quarterly report.

"All markets would be affected but the effect would be more substantial in high-priced markets - more than five percentage points in the case of Vancouver."

Of course, there are other factors at play, too, such as higher incomes, to help blunt the blow.

Still, "rising interest rates and more stringent qualifying rules for uninsured mortgages coming into effect in January are poised to raise the bar significantly for many buyers in Canada."

Mortgages

Well, first of all, it's going to be harder for some people to get one.

Or they'll have to scale back their mansion dreams given the new OSFI stress tests for uninsured mortgages, which force some buyers to show they could handle rates much higher than the ones they're being offered.

Then, more importantly for costs, there are rising rates to factor in.

"Household income would need to climb by 8.5 per cent to fully cover the increase in home-ownership costs arising from a 75-basis-point hike in mortgage rates," said RBC's Mr. Hogue and Mr. Wright.

The latest OSFI numbers suggest Canadians were scrambling to beat the new rules, noted National Bank analyst Gabriel Dechaine, with an 18-per-cent increase in uninsured mortgages in October compared with a year earlier.

And that could be carrying into the early part of this year.

"We expect that accelerated growth of uninsured mortgage volumes could persist in coming months as borrowers attempt to avoid tougher [OSFI] guidelines," Mr. Dechaine said.

"Moreover, the trend could continue in early 2018, as bank customers "buy time' by obtaining mortgage preapproval, which could allow them to purchase a home under older underwriting guidelines for an extended period (i.e., up to 120 days)."

David Rosenberg, chief economist at Gluskin Sheff + Associates, suggested as 2017 was winding down that "it could well be that the banks are already beginning to tighten up the lending spigots."

The banks

There's "added uncertainty as the impact of the new mortgage rules could weigh on the banks' mortgage origination growth," said Barclays analyst John Aiken, noting some of the banks themselves suggest the new regime could affect between 5 and 10 per cent of new mortgages.

Mr. Aiken estimated that growth in mortgages and home equity lines of credit, or HELOCs, eased in the final three months of 2017, to 1.5 per cent from 2.4 per cent in the third quarter. And it all makes for short- and longer-term issues.

"We believe recent positive monthly home sales activity (August to October), could offer a reprieve from the slower summer selling season (four straight monthly declines between April to July), supporting mortgage growth to start off the year," Mr. Aiken said in a lengthy report in the country's major banks.

But "exacerbated by the slower winter selling season, we anticipate the demand for mortgages could be tested by mid-2018," Mr. Aiken warned.

"Heading into [the first quarter of 2018], however, we anticipate mortgage growth will remain positive, and, on a consolidated basis, we are forecasting the pace of growth to ebb further from Q4's run rate, up 1 per cent sequentially."

All of that said, Barclays is "becoming more enthusiastic" on the outlook for the big banks amid the economic backdrop and gradually rising interest rates.

"Further, there does not appear to be too much disruption on the horizon that would cause any concerns regarding employment in North America and, while we cannot forecast anything but some moderation in credit, we do not see any material deterioration as being likely," Mr. Aiken said.

"That said, we do not expect much of a ramp-up in earnings growth for the Big Six (5.2-per-cent average growth against 5.6 per cent for consensus)," he added.

"However, as earnings outside of Canada are expected to accelerate (in the face of potential slowdowns in domestic earnings), relative exposures and strategies are now more important in determining relative performance."

The rush to beat the new rules, of course, could be setting the banks up for something slower as 2018 rolls on.

"While these borrowing strategies could lead to surprisingly high mortgage volume growth into the new year, we believe evidence thereof could amplify concerns of a mortgage (and broader housing sector) activity drop-off in the balance of the year," said National Bank's Mr. Dechaine.

"Although we are not housing bears, we do appreciate investor sensitivity around housing-related issues that can easily dampen sentiment."

Note this, too: The latest report on economic growth showed shrinkage in the finance and insurance sector of 0.2 per cent in October, Gluskin Sheff's Mr. Rosenberg pointed out, bringing to four months the string of contractions.

"Over this interval, output in this key sector has declined at a 3.5-per-cent annual rate," Mr. Rosenberg said.

"We have not seen a stretch of weakness like this since the bank stocks took it on the chin in 2011. Before that, it was February, 2009."

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Markets at a glance

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What to watch for today

Investors get to see what Federal Reserve policy makers were thinking and saying when they raised their benchmark lending rate in December.

The minutes from that meeting of the Federal Open Market Committee, the U.S. central bank's policy-setting group, will be released in the afternoon.

"The minutes from the Dec. 12-13 FOMC meeting will be scoured for clues to Fed policy in 2018," Bank of Montreal deputy chief economist Michael Gregory and senior economist Sal Guatieri said in a lookahead to Wednesday.

"Specifically, we'll be looking for answers to three questions."

Question 1: Fed policy makers, in their individual projections at the December meeting, were looking for three rate hikes in 2018. But "with the economy now essentially at full employment and no longer sporting an output gap, is there a sense among FOMC participants that, unlike the other rate-hike years (2015-2017), the balance of risks now weigh on the side of more rate hikes, not less?"

Question 2: Those projections also included a stronger economic outlook and lower unemployment but little change in the inflation outlook. "Is the Fed betting that current secular disinflationary trends (owing to the likes of technology-enabled disruption and globalization) will continue to counter cyclical inflation pressures, and that tax cuts will spur more capacity growth?" said Mr. Gregory and Mr. Guatieri.

Question 3: The Fed dropped its reference to "the balance sheet normalization program." And, thus, "was this an overt attempt to downplay the on-auto-pilot program and a covert sign of Fed confidence in the conjecture that there's minuscule risk of collateral damage for financial markets from balance sheet shrinkage? We aren't so confident."

It gets interesting here because market players tend to scour these minutes for signs of what might come next.

But up next is a new Fed, with U.S. President Donald Trump's choice for chair, Jerome Powell, set to take over in February. Other fresh faces are also coming in.

"If President Trump's Fed board nominee (Marvin Goodfriend) is confirmed soon, only four of nine members at the March, 2018, meeting will have also been a member in December, 2017," said Mr. Gregory and Mr. Guatieri.

"And, one of them, NY Fed president [William] Dudley, will depart mid-2018. Potentially, the Fed might sound and act much differently as 2018 unfolds."

Today also brings more PMIs, notably the widely watched ISM reading in the U.S., which economists generally expect to come in at about 58, the 50 mark being what separates contraction from expansion.

It stood at 58.2 in November, and "our expectation for the ISM is for it to move away from current extreme levels," said Andrew Grantham of CIBC World Markets.

"Even in the best expansionary periods historically, spikes close to and above the 60 mark have typically only lasted a few months," he added.

"Readings in the mid-50s are much more common. As such, even though our forecast for a drop to 57.1 is below the consensus, it would still be well in expansionary territory and consistent with solid growth in the sector."

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