Policy action provides partial fix to Canada's housing market imbalance

COVID-19 added fuel to a housing market that was already running hot due to lack of supply in many parts of Canada. Two big questions going into the spring market were: 1) would policymakers step in to address major imbalances; and 2) would soaring prices set self-correcting forces in motion, turning buyers away and attracting more sellers?

The answer to both, so far, is a very small yes. Policymakers announced several measures, but opted for a light touch. Meanwhile, super-tight demand-supply conditions improved slightly, with frenetic resale activity easing in April and May. Neither will make much difference to house-hunters who continue to try to outbid each other amid exceptionally low inventories and fast-rising prices.

Canada’s housing market will have to adjust to several policy changes over the coming months. But in our view, none will restore balance to the housing market in the near term. With meaningful relief of market tensions still several months off, we expect resale activity to stay historically strong (albeit at more sustainable levels than seen earlier this year) and prices to continue to rise. Indeed, we now expect Canadian home-resale activity to be up 16% this year over last—a big upward revision from our January forecast for a 6.5% increase. Price increases will also be in the double-digits. A much-desired soft landing has been pushed into 2022.

Policymakers tread lightly

Amid growing concerns about bubble-like conditions, federal policymakers tapped into their existing playbook, tightening the mortgage stress test and earmarking more funding for rental housing (see Box A). They also took a page from British Columbia’s playbook, announcing plans for a Canada-wide 1% tax on the value of vacant or underused residential properties owned by non-resident foreigners starting January 1, 2022. The Bank of Canada left its position on housing unaltered, indicating it sees government policy—not monetary policy—as the best tool to tackle rapid home-price increases.

The tightening of mortgage stress test rules will further protect highly leveraged borrowers against the risk of an interest-rate surge down the road. The modest extra housing supply for Canadians in need is welcome. Neither addresses the thorny problem of low supply in a market hungry for new ownership options. Indeed, the expansion of the First-Time Home Buyer Incentive in Toronto, Vancouver and Victoria (allowing higher-income buyers to qualify, and raising the admissible property value limit), and broader eligibility for the GST rebate on new housing, will only further stoke demand. As for the tax on the vacant and underused properties, it’s unclear whether B.C.’s experiment helped cool investor demand or coaxed more homes into the ownership pool—though it did help to draw more units into the rental market.

Our view: a light touch, not a game-changer

Canadian policymakers mostly ignored calls for forceful action. While the light touch may be of comfort to some, in our view it only prolonged the much-needed rebalancing of Canada’s housing market. With so many policy changes to digest, we lay out the following considerations for market participants.

1. No major overhaul of the policy regime is on the way. It will still be tilted in favour of home ownership. First-time buyers in Toronto, Vancouver and Victoria will even get some extra help.
2. Demand-side policy tweaks are much more about strengthening the resilience of households and the financial sector than actively cooling the market. Even the latest stress-test adjustment will have a more limited impact on demand than the initial introduction of the stress test had in January 2018.
3. On the supply side, the federal government is focusing on squeezing more ‘productive’ units out of the housing stock and building rental housing for Canadians in need. But it’s unclear how many ‘unproductive’ units there are in Canada.
4. The federal government is taking a pass on incentivizing (or pressuring) municipalities to address the length and burden of housing project-approval processes, as well as planning and zoning issues that stand in the way of new supply. Slow approvals, and zoning and other regulatory obstacles have been at the core of Canada’s escalating prices over the past 10-15 years.
5. The Bank of Canada will provide research and analysis on the housing market, and sound the alarm bell if needed, but won’t raise interest rates to cool housing demand.

Self-correcting forces won’t materialize overnight

Without a major policy catalyst—like B.C.’s surprise foreign-buyer tax and Ontario’s Fair Housing Plan were in 2016 and 2017, respectively—other factors will drive the market rebalancing process. We expect a modest, gradual rise in long-term interest rates, deteriorating affordability, mortgage stress test tightening and the resumption of office work to cool demand a few degrees over time. High property values could also entice more owners to sell. These factors are unlikely to deliver quick results. And so long as demand-supply conditions remain tight, prices will escalate further. Rising prices, in fact, will be an integral part of the rebalancing process.

Home resales, prices to rise sharply in 2021

Under these circumstances, and given activity so far this year has been much stronger than we previously anticipated, we’ve revised our housing forecast higher. We now project home resales in Canada to rise 16% in 2021 to 636,700 units, up from the 588,300 units we projected in January. We expect the monthly pace to moderate over the remainder of this year and into 2022, producing a noticeable 21% annual drop next year to 505,300 units—still a solid level of resales historically.

We’ve also boosted our 2021 home price forecast to an increase of 14.1% to $707,000 for the national RPS HPI benchmark, from a gain of 8.4% previously. We expect price pressure to start easing later this year, setting the stage for a more modest 2.9% appreciation in 2022.

Affordability continues to take a hit

For existing homeowners, this soft-landing scenario would be a favourable outcome, preserving huge gains in property values. It would be a very different story for future first-time buyers. The run-up in prices through the pandemic has already resulted in mortgage payments increasing $330 to $2,500 per month for a standard house in Canada (valued at $724,000 in April). Our projected price increase over the next 12 months (4.2%) would add another $150 per month, making ownership costs that much harder to handle. The down payment for that house has also gone up. Clearly, future buyers will face more intense affordability pressure across many parts of the country. Home ownership will become a more distant dream for an increasing number of Canadians. And a heavier debt load will come to those who will realize it.

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Robert Hogue is responsible for providing analysis and forecasts on the Canadian housing market and provincial economies. Robert holds a Master’s degree in economics from Queen’s University and a Bachelor’s degree from Université de Montréal. He joined RBC in 2008.

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