Canada Joins Fight to Cool Elevated Home Prices: QuickTake Q&A

Canada has closed a tax loophole used by foreign home buyers, the latest move to tame soaring prices and prevent a housing market crash. The new measures mean foreigners will no longer be able to claim a capital gains tax exemption on the sale of their principal home -- a tax break now reserved for residents. The changes announced by Finance Minister Bill Morneau add to moves taken by the province of British Columbia, which enacted a 15 percent tax on foreign home buyers in Vancouver, the country’s most expensive market. The tax is intended to make housing more affordable in Vancouver, but critics say it doesn’t go far enough and early data shows prices and sales dropping there. Foreign buyers, it turns out, are only one reason prices continue to rise, though slower than last year.

1. Why is Canada’s housing market so hot?

Rich foreigners -- particularly from China -- have been blamed by government and locals for soaking up the limited supply of houses and condos. The average low-rise home price in Vancouver has shot up almost 70 percent to C$1.58 million ($1.23 million) in the last five years and about 60 percent, to C$785,500, in Toronto. Sales in the two cities hit a record in May, and price growth up to then outpaced even Manhattan, according to custom data from Zillow. Now residents priced out of Toronto and Vancouver are moving out and driving up sales and prices in sleepy nearby towns.

2. How did we get here?

Blame a perfect storm of depressed interest rates, limited housing supply and city planning policies. Armed with cheap debt, buyers are overextending themselves: An overnight lending rate near a record low means some mortgage rates are as low as 2.28 percent. Vancouver’s sprawl is limited by the Pacific Ocean on one side and mountains on the other, Toronto’s by an ecological reserved territory, the Green Belt. And since the 1980s, the Canadian government has been encouraging offshore investment, at one point even establishing a national investor program to fast-track citizenship applications.

3. What are officials doing about it?

In addition to the tax changes for foreign home buyers, Canada tightened requirements on mortgage insurance and plans to carry out stress tests on insured mortgages. In December 2015, the government also raised down payment requirements on homes over C$500,000. The government may ask banks to hold more money backing property loans in case of default.

4. Where else have steps like this been tried?

In Australia, foreigners generally now need to seek approval before buying residential real estate, are required to pay extra fees and can be penalized heavily if they don’t comply. Switzerland doesn’t allow any purchase of residential real estate by non-residents, though investors can get around the rule by applying for a Swiss residence permit. Hong Kong taxes non-resident home buyers an additional 15 percent. On Canada’s east coast, Prince Edward Island limits purchases by non-residents -- even Canadians from other provinces -- to five acres.

5. Will it work?

According to experts and history, not really. After Canada raised down payment requirements, home sales went on to post records in Vancouver and Toronto. Even as Australia implemented its offshore buyer rules, home prices continued rising and investment increased. To skirt tighter bank rules, buyers can go to non-bank lenders, aka the shadow market. Rich investors from abroad can find ways around the crackdown.

6. What’s next?  

Vancouver has been granted power by the province to tax empty homes. In Ontario, Finance Minister Charles Sousa said he’s keeping his eye on the effects of the foreign owner tax, though Toronto Mayor John Tory is doubtful anything will be implemented in the near-term. Meanwhile the country’s housing agency, which insures home loans under C$1 million as well as securitized debt, has been looking at ways for banks to have more skin in the game for at least two years. Morneau has set up a public consultation process to review ways in which banks can take on a “meaningful” level of exposure to mortgage default risk.

The Reference Shelf

  • A Noah Smith column on China sending real-estate bubbles to North America.
  • Scenes from Vancouver, playground of the rich.
  • A University of Alberta China Institute research paper on foreign investment in Canadian real estate.
  • A story, based on a C.D. Howe report, about the risk of a mortgage meltdown.
Before it's here, it's on the Bloomberg Terminal.