A Q&A on Canada's housing policy options
The resilience of Canada’s housing market—in the face of a global pandemic and resulting severe economic shock—has been nothing short of extraordinary. But with activity and prices headed for the stratosphere, what was initially viewed as a positive development is now causing some hand-wringing. In this note, we address some common questions about the situation and potential policy responses.
What’s the main issue with the Canadian housing market right now?
A: It’s overheating. Demand is exceedingly strong, inventories are generally low, and property values have soared to levels far outside historical norms. Making matters worse: buyers and sellers expect prices to continue to escalate. Until recently, Canadian housing-market worries mostly reflected conditions in Toronto and Vancouver. Now, it’s a national concern. In fact, prices are rising fastest in smaller markets like Mission BC, Tillsonburg ON, Sainte-Adèle QC and Moncton NB. These factors have pumped up mortgage borrowing—which is rising at the strongest rate in nearly a decade (7.2% y/y in January)—and the size of new mortgages. These conditions will only add to Canadian households’ heavy debt load.
Q: Why is Canadian housing demand so strong?
A: Large population in-migration and solid labour markets had housing demand running hotter than supply in many parts of Canada before the pandemic. The pandemic cranked up the heat. The drop in interest rates to rock-bottom levels, changing housing needs and surging household savings have all stoked demand. Surging prices are also pulling demand forward, with many buyers opting to act now for fear they’ll miss out. The factors driving the current frenzy will eventually reverse or run their course. As we bring COVID under control, interest rates will gradually increase; housing needs will change more slowly; and household savings will return to normal levels. However, it’s difficult to know when that will be.
Q: Should policymakers do something about overheating markets?
A: Yes, for several reasons. 1) Overheated markets threaten to destabilize the economy down the road if or when a correction occurs, with possible heavy costs for governments. The threat is particularly potent because excessively high price expectations are widespread. Canada hasn’t had a market overheating of this scope since the late 1980s. 2) Capital used to inflate real estate values isn’t going to more productive purposes in our economy. The misallocation of capital undermines longer-term growth prospects. 3) Sky-high property values can exacerbate inequality, widening the divide between haves and have-not. Exorbitant land prices make it more expensive to build more affordable housing.
This isn’t to suggest there are glaring policy holes to fill in Canada. Canadian policymakers implemented several rounds of rule tightening after the global financial crisis in an effort to calm activity in the priciest markets. These measures strengthened the resilience of Canadian households and the financial sector, and limited the federal government’s exposure to any housing market downturn.
Lastly, don’t look for the Bank of Canada to alter its policy course to address housing-market issues. It made it very clear long ago that it sees macro prudential measures as the appropriate tools to use.
Q: What are some options to address lack of supply and strong demand?
A: First off, policymakers should re-double efforts to address supply issues that existed before the pandemic. These include lightening the regulatory burden for new housing approvals to quicken supply response; adjusting municipal zoning to allow more medium-density, family-friendly housing in large urban areas (the so-called ‘missing middle’); growing Canada’s stock of affordable housing significantly; and removing disincentives to build (market) rental apartments—or better yet, tipping the scale in their favour. The need for more affordable rental options for ordinary Canadians is greater than ever. Most of the supply-side measures we’ve outlined here fall into local authorities’ lap, although higher levels of government have a role to play. However, they aren’t quick fixes.
Further tightening of mortgage-lending rules could be necessary if signs of household debt stress emerge. Historic government aid and financial institutions’ debt payment deferral programs have distorted the household debt picture since the pandemic—debt ratios, and delinquency and bankruptcy trends look surprisingly benign. There could be issues brewing beneath the surface, however. Policy options include a stricter stress test, raising the minimum down payment and lowering the cap on refinancing.
Policymakers should look at a range of options to discourage speculative activity as this could generate further volatility. We find New Zealand’s just-announced phasing-out of mortgage interest expense tax-deductibility for investors an interesting proposal.
Over the longer term policymakers should undertake a more holistic review of housing policy to ensure it is not contributing to any distortions in the market. The housing policy mix should be revisited to reflect a changing economic environment, evolving demographics trends and a lower for longer interest rate backdrop. Given wide-reaching implications, a thorough, comprehensive examination of all related aspects would be necessary. One of the more significant proposals would be to revisit the principal residence exemption from capital gains tax. With many Canadians having built their wealth (and retirement plans) on realizing the full value of their home, any amendments would have to carefully balance the impact on the housing market and the financial security of Canadians, and apply only on a go-forward basis. Always complex, such a proposal may prove more of a theoretical exercise than a politically viable one.
One thing is certain: there are no silver bullets. All demand-side options have side-effects and work, at best, for a limited time.
Q: In the context of the current housing market, what should policymakers not do?
A: They should steer clear of taxing transactions (e.g. land transfer tax) and other measures impeding labour mobility or the ability of Canadians to move to a better-suited home. They should also resist providing more help for first-time homebuyers. Without corresponding measures to boost supply, any measures that ultimately heat up demand further—while probably helpful to the first people who take advantage of them—increase the odds of perpetuating problematic price trends and household debt issues.
Robert Hogue is a member of the Macroeconomic and Regional Analysis Group, with RBC Economics. He is responsible for providing analysis and forecasts for the Canadian housing market and for the provincial economies. His publications include Housing Trends and Affordability, Provincial Outlook and provincial budget commentaries.
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