Special to CMT, Will Dunning, Economist

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Once again we’re hearing chatter about overheated housing markets, and there are calls for new macro-prudential measures to reduce housing activity.

This time is a little bit different, however, as there’s recognition that the heat is localized (Toronto, Vancouver and their surrounding areas). The suggestion is that the measures should be specific to those localities, as it would be unproductive to further impair other markets that are already soft.

What isn’t being said is that the prior measures were effective at reducing demand, but they were counter-productive. Activity was reduced in the weakest market areas but largely unaffected in Vancouver and Toronto (which were the intended targets). This is most notably the case for the changes made in July 2012 (chiefly the elimination of 30-year amortization for insured mortgages). That change continues to weigh on housing markets. In most places, activity is still less than it should be, based on the fundamental factors of job creation, low interest rates and excellent affordability.

In Toronto and Vancouver, the underlying problem has been prolonged insufficiency of supply. Even if demand has been reduced by the July 2012 changes, the volume of activity has been determined not by demand, but by the supply constraint. The real problem in those markets has not been addressed. The consequence is that house prices have continued to increase sharply and, in fact, price growth has accelerated recently.

The expanding influence of foreign buyers

For some time, Canada Mortgage and Housing Corporation has attempted to estimate the extent of foreign buying in segments of Canadian housing markets. Some informed observers have expressed skepticism about the reliability of those estimates, and now the government has asked Statistics Canada to try its hand.

It strikes me as quite unlikely that reliable estimates can be developed on foreign buying within a timeframe that would allow for effective policy responses.

Yet, there is sufficient anecdotal evidence that the role of foreign buyers is very substantial in Vancouver and that the Vancouver housing market is being severely distorted in consequence.

In Toronto we do not have that depth of anecdotal evidence, but recent events have led to suggestions that a similar set of effects may now be developing.

The pair of charts below provides one kind of market evidence, which confirms that some form of distortion is occurring in the Vancouver and Toronto markets. This may be reflective of changing activity by foreign buyers.

The charts compare growth rates in two data sets of house prices: the average prices reported by the Canadian Real Estate Association (CREA) versus the price changes shown by the Teranet/National Bank house price index.

CREA numbers can be influenced by changes in “composition” in the market, whereas Teranet data is not affected by composition: it’s (in theory) “pure price” changes. Therefore, where there are big differences in the two data series, the most likely cause has been a change in the composition of the market. When CREA data shows larger rises than Teranet, it’s likely that activity has shifted into the higher reaches of the market (and, conversely, there are periods when CREA shows less increase than Teranet, which indicates a downshift in the composition).

For some time, the Vancouver data has shown distinct waves of distortion that most likely have been due to changes in composition. In Toronto, by contrast, for most of this history, there have been smaller differences between the two sets of estimates. But, in Toronto, a large gap has opened during the past year. This tells us that there has been a large shift in composition, with a substantial rise in high-end activity.

A further note on the two charts: In the Vancouver data, the gap has closed in recent months and, for May, the CREA growth rate was lower than the rate from Teranet. Although it’s too soon to say there has been any kind of turning point, this recent situation indicates that activity is not currently shifting upwards. This could be caused by a stabilization of activity by foreign buyers. In Toronto, on the other hand, the gap seems to be growing, showing increased shifting into the upper reaches of the market. This may mean that foreign buyers are currently becoming more active.

In both Vancouver and Toronto, we’re currently seeing extremely high sales levels.  

My interpretation of the data in both markets is that there has been strong locally-generated demand across the spectrum (due to the favourable combination of job creation and affordability). On top of that there is elevated activity within the high-end housing markets in both Toronto and Vancouver. The incremental activity from foreign buyers is increasing total sales activity (and distorting the average price). In these supply-constrained markets this, in turn, is accelerating the rates of actual price growth.

This set of patterns is exactly what we would expect if foreign buying is being added to local demand: wealthy foreign buyers will target prestigious and high-priced locations. The data does not prove that foreign buying is adding to the heat in these two markets, but it’s consistent with the idea.

Policy Implications

Regarding foreign buyers, there’s no point in waiting for better evidence of their role (and we are unlikely to find better evidence any time soon). Based on the anecdotes in combination with the implications that we can tease out of the data, we should be confident that foreign buying is a major incremental factor that’s resulting in over-heating, certainly in Vancouver for a long time, and possibly now in Toronto.

Based on the anecdotes, we can also be confident that some substantial part of the influx of capital is from buyers who want to hide assets from their own governments. Notably, the influx has coincided with a crackdown on corruption in China, and more recently with attempts by the government to control the exit of capital from China.

Further, we may be able to get useful data on foreign buying from administrative sources (in particular from taxation data or in declarations that buyers must make at the time they make purchases).

In other words, proceeding with reasonable regulatory changes will, in addition to addressing policy needs, also result in data that can be used later to review and fine-tune the policies.

Action or paralysis?

I’m a huge fan of “evidence-based” decision making. But, sometimes we don’t have good data and our only evidence is opinions. This is one of those situations.

The government could quickly create some useful evidence, via a study of international best practices, which could be introduced in Canada within a reasonably short period of time. It should be expected that those policies will evolve over time, as the data that results can be used in analysis.

Does the government really need to hurt Canadian homebuyers?

Regarding current strong demand from Canadian buyers, we have a long-established and reasonable set of criteria for mortgage lending in Canada. We know that, among Canadians who are currently borrowing via mortgages, an enormous majority are able to meet their payment obligations. The Canadian Bankers Association reports an arrears rate of just 0.28% (just one out of every 354 mortgage borrowers). Moreover, as the semi-annual reports from Mortgage Professionals Canada have demonstrated repeatedly, Canadians are highly motivated to repay their mortgages and the majority of mortgages are fully repaid in considerably less time than the original contracted amortization periods.

Changing mortgage lending criteria in response to pressures that are originating outside of the country would unnecessarily punish Canadians who have reasonable expectations of homeownership.

As well, that would unnecessarily impair housing markets in Canada, which would have economic consequences. As noted earlier, a set of changes to mortgage insurance criteria that was imposed in July 2012 significantly impaired housing activity and continues to have costs. There is evidence that the July 2012 change is still causing housing market activity to be somewhat less than it would otherwise be.

Shortly after the July 2012 policy change (in early 2013), job creation weakened in Canada, and since then job growth has been weaker than the rate of population growth. The share of the population that has jobs has fallen during the past three years, which is disappointing. There have been multiple causes of the weaker job creation, but the deliberate impairment of the housing market is one of those causes of economic disappointment. Any new actions that prevent some qualified Canadians from entering homeownership would further impair the Canadian economy.

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Will Dunning is the Chief Economist for Mortgage Professionals Canada, as well as operating his own consulting firm, which specializes in analysis of housing and mortgage markets. For Accredited Mortgage Professionals, his presentations on “Analyzing and Understanding Canadian Housing and Mortgage Markets” qualify for 1 CEU credit in the compulsory category.