Home Buyers Lose Steam, and Cash, as Canada Rate Hike Looms

  • Anticipated monetary tightening risks worsening home sales
  • Analysts expect Canada housing market to cool, not crash

Toronto Home Demand Slides as Sales Drop Most in 8 Years

Broker John Pasalis knew Canada’s hottest housing market was cooling but an email from desperate sellers showed him just how bad it was.

A young couple had been looking to cash in on their three-bedroom home in a Toronto suburb after prices rose 25 percent in April from the prior year. They soon found first-time buyers who agreed to pay C$900,000 ($699,000) and, assured of the deal, the couple bought another larger home further away from the city. But the market began to turn just before the closing date in June, and the buyers reneged on the deal, forfeiting their C$40,000 deposit.

Plunging sales, a surge in listings, and eroding prices that spooked these buyers may worsen if the Bank of Canada raises borrowing costs as expected this week. The move would be the latest blow for a market that’s become unhinged in just three months, with the near-collapse of mortgage lender Home Capital Group Inc. and as policy makers look to rein in runaway prices and risk.

“There’s a bit of a domino effect, it’s all sort of happening right now and we don’t know the extent of it," said Pasalis, president of brokerage Realosophy Realty Inc. in Toronto. “People are digesting rules, the amount of inventory on the market with lower prices -- and there’s even more to come."

‘Dangerous and Deflationary’

The chain of events began in October when the federal government tightened mortgage insurance requirements, and continued into April when the province imposed a 15 percent tax on foreign purchasers. Home sales fell 37 percent in June from a year earlier and prices rose the least since January 2015. Then last week the regulator said it’s considering requiring lenders to stress test uninsured mortgages, which is expected to cool things further.

On top of all this, Governor Stephen Poloz will lift the benchmark overnight rate on Wednesday to 0.75 percent from 0.5 percent, according to 22 of 31 economists in a Bloomberg survey while the rest see no change. The rate could rise to or past 1 percent in a year, a separate survey shows. In anticipation, Canada’s biggest banks are also tightening. Royal Bank of Canada raised its fixed rates for 2-,3-, and 5-year term mortgages by 20 basis points.

A 75 to 100 basis point increase in the Bank of Canada’s key rate by the end of 2018 would remove 6 percent to 8 percent of buyers from the country’s real estate market if banks fully price it into their loans, according to Will Dunning, chief economist at industry group Mortgage Professionals Canada. A slowdown in property deals may pose a risk to Canada’s growth -- the fastest among Group of Seven countries -- just as the economy seems to be overcoming a slump triggered by a drop in global oil prices.

“Right now people are staying away from buying," Dunning said by phone. "If they stay away over a longer period of time, that could become dangerous, that could become deflationary."

Stress Tests

The Office of the Superintendent of Financial Institutions announced Thursday it’s considering three measures targeting over-leveraged borrowers in the uninsured mortgage market, which comprises about half the C$1.5 trillion mortgages outstanding in the country. They include asking lenders to stress test uninsured mortgages, or those borrowers who put at least a 20 percent downpayment, and matching the loan-to-value ratios, or the loan amount compared to how much the house is appraised at, with local market conditions.

If finalized, the OSFI requirements would hit the alternative lending market harder than Canada’s six big banks. In such a scenario, residential mortgage debt growth would slow to as little as 2 percent each year from 6.3 percent now, Royal Bank of Canada analysts including Geoffrey Kwan and Darko Mihelic wrote in a July 9 note titled “Cruel Summer." Laurentian Bank Securities analyst Marc Charbin downgraded Home Capital to a hold from buy rating, forecasting a slowdown in loan growth. He also lowered the target price for the alternative lender and its rival Equity Financial Holdings Inc.

The October rules, which included stress-testing borrowers at a mortgage rate 200 basis points higher than what’s offered, would disqualify about 1 in 5 hopeful buyers, according to a survey by Mortgage Professionals Canada.

Craziest Markets

A rate increase from the central bank may price people out of the property market but it’s not necessarily a bad thing, said Craig Wright, chief economist at RBC Capital Markets. A debt-to-income ratio hovering near a record “suggests the economy and consumer sector is more sensitive to smaller increases in interest rates than we’ve seen in the past,” he said. “It will have an impact -- it’s exactly what rates are supposed to do. But it’ll be a cooling in the market, not a collapsing.”

Canadian housing starts increased to about 212,700 in June, outpacing even the most optimistic economist forecast of 210,000 units, Canada Mortgage & Housing Corp. said. It fills in much-needed home supply that’s lacking in the resale market in Toronto.

James Laird, president of brokerage CanWise Financial, is seeing an increasing number of clients refinancing and renewing to lock in the low rates. That’s why he said a single rate hike won’t have much of an impact, and he’d only be worried if tightening is stepped up to about 300 basis points. Laird also welcomes the return of rationality.

“It was one of the craziest real estate markets I’ve experienced in the last 10 years," he said. "The bidding wars were wild. That pivoted fairly quickly this spring."

— With assistance by Erik Hertzberg, and Natalie Obiko Pearson

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