Canadian homebuyers losing steam, and cash, as rate hike looms

Register now

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% 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% tax on foreign purchasers. Home sales fell 37% 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% from 0.5%, according to 22 of 31 economists in a Bloomberg survey while the rest see no change. The rate could rise to or past 1% 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 two-, three- and five-year term mortgages by 20 basis points.

An increase of 75 basis points to 100 basis points in the Bank of Canada’s key rate by the end of 2018 would remove 6% to 8% 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 is considering three measures targeting overleveraged 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% down payment, 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% each year from 6.3% 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.

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.”

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."

Bloomberg News