mortgage lending

RBC Says Policy Response Needed to Tackle Soaring House Prices

...including the possibility of a capital gains tax on principal residences

Watching Canada’s national average home price rise resiliently throughout the pandemic has been reassuring for many over the past year. But as prices continue to increase unabated, it’s now starting to illicit concern.

RBC Economics became the latest to sound the alarm over the “national concern” that rapidly rising house prices are posing. In a report published on Wednesday, it called for policy-makers to act to constrain prices that are “headed for the stratosphere.”

“Overheated markets threaten to destabilize the economy down the road if or when a correction occurs, with possible heavy costs for governments,” reads the research note, penned by RBC economist Robert Hogue. “The threat is particularly potent because excessively high price expectations are widespread.”

He pointed to recent data showing overheating is no longer limited to major housing markets like Toronto and Vancouver. Prices are now rising fastest in smaller, outlying markets, including Tillsonburg, ON, where the average home price soared nearly 40% year-over-year in February.

“Demand is exceedingly strong, inventories are generally low, and property values have soared to levels far outside historical norms,” Hogue wrote. “Making matters worse: buyers and sellers expect prices to continue to escalate.”

A recent Nanos poll confirmed this, finding a full 60% of Canadians now expect house prices in their neighbourhood to increase over the next six months. Bloomberg News noted this is the first time the result has surpassed 60% since polling began in 2008.

“This fear of missing out is out there and it’s driving people to make decisions they’ll have to live with,” Hogue told Bloomberg.

Which housing policies are being proposed?

First and foremost, Hogue is calling on policy-makers to focus on efforts to address the inadequate housing supply, which has been an issue since before the pandemic.

“These include lightening the regulatory burden for new housing approvals to quicken supply response; adjusting municipal zoning to allow more medium-density, family-friendly housing in large urban areas…; growing Canada’s stock of affordable housing significantly; and removing disincentives to build (market) rental apartments,” he wrote.

He also pointed to policies that will “discourage speculative activity,” as in New Zealand, which announced it will be phasing out mortgage interest expense tax deductibility for investors.

“More fundamentally, governments should take a broader look at the support they provide to homeownership, and the degree to which it contributes to extrapolative price expectations,” Hogue wrote.

“Policy-makers should put everything on the table, including sacred cows like the principal residence exemption from capital gains tax,” he added. “These considerations will be complex, controversial and no doubt fraught with unintended side-effects. Yet this support was largely designed during times when interest rates were much higher, and in some cases to counter the effect of high rates.”

Hogue also suggested further tightening of mortgage lending could be necessary “if signs of household debt stress emerge.” But he added policy-makers should avoid introducing new taxes on transactions, such as land transfer taxes, and other measures “impeding labour mobility or the ability of Canadians to move to a better-suited home.”

“They should also resist providing more help for first-time homebuyers,” he wrote.

Growing Concerns About the Housing Market

RBC is just the latest to point out that 20-30%+ gains in house prices aren’t sustainable.

As we reported recently, the Globe and Mail recently published an editorial saying the pace of price gains is making the case for a capital gains tax on primary residences. The piece noted prices are up 270% since 2000.

Bank of Canada Governor Tiff Macklem also hinted at concerns in a speech last month, where he said, “We are starting to see some early signs of excess exuberance,” in the housing market.

While he said the situation isn’t yet as dire as it was in 2016-17, he did say a big concern is “extrapolative expectations, when we start to see people expecting the kind of unsustainable price rises we’ve seen recently go on indefinitely.”

However, given the BoC’s recent forward-guidance that it will keep rates low until 2023, Hogue says policy support will have to come from sources other than the Bank of Canada.

“With the Bank of Canada committed to keeping interest rates low for an extended period of time, we believe policy support for homeownership needs to be recalibrated,” he wrote.

Wherever the source of that policy, it’s clear that pressure is building for some kind of response to today’s sky-high prices.

Looking to the past, run-ups in home prices have tended to precipitate the introduction of new mortgage rules. This happened in 2016, when the Office of the Superintendent of Financial Institutions (OSFI) announced stricter capital requirements, followed by restrictions on mortgage insurance. It happened again in 2017, with OSFI’s stress test on uninsured mortgages.

What can we potentially expect in 2021? Only time will tell.

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