September Market Update
Summer is traditionally a slower time for real estate and 2012 was no different. Lower sales activity had several prognosticators predicting that Canada’s housing market would see a correction; however, to date, prices have remained relatively stable in most jurisdictions. In fact, Vancouver’s seemingly inflated Westside saw its average price rise by 15% over August 2011 thanks to a relatively low sales volume and several significant transactions (this is why last month we talked about how misleading ‘average’ statistics can be).
But aside from internal market forces, it’s hard not to ignore how problems in the US and Europe and the resulting economic turmoil will influence our housing market. And while it’s true that consumer confidence plays a big role in the overall health of housing, it’s important to remember that Canada continues to look like an economic oasis in a desert of bad financial news.
As you know, the US housing market has been in a severe recession for the past several years. And while there’s been talk of a possible correction in the Canadian housing market, it is unlikely we will experience anything near as painful as our neighbours to the south.
There are 3 main reasons for this.
(1) Government Tax Policies
(2) Loan Qualification Policies
(3) Bank Lending Policies
Government Tax Policies
The US Government has long had a policy of encouraging home-ownership. Government-sponsored entities Fanny Mae and Freddy Mac received most of the headlines during the US housing crisis for agreeing to purchase mortgage loans that encouraged unsound lending. However, the US Government’s tax policy of allowing homeowners to deduct mortgage interest payments may be more significant, as it has encouraged Americans to maximize their debt-loads in order to minimize their tax burdens.
Canada, of course, has no mortgage tax break for homeowners, with interest payment deductions only applying to investment properties, meaning that Canadian homeowners don’t have an incentive to take out larger loans than they can afford.
Loan Qualification Policies
The secondary mortgage market in the US allowed the originators of mortgages to pass on the mortgage notes to investors throughout the world. Because of this, lenders became incentivized to originate as many mortgages as possible, with little-to-no regard for risk. These perverse incentives led to ‘liar loans’ – where individuals would simply lie to their mortgage broker about their income or employment knowing that there would be no incentive to conduct a background check – and ‘NINJA loans’ – where mortgage brokers offered mortgages to individuals with No Income, No Job or Assets.
In Canada, the originators of loans (typically the Big Banks) tend to hold on to them. Because of this, the correct incentives are in place to ensure that only individuals who can afford the mortgage receive them.
Bank Lending Policies
Another unintended consequence of the secondary mortgage market in the US has been the creation of extensive Adjustable-Rate Mortgage products with attractive ‘teaser’ rates to take advantage of sub-prime borrowers. These products allowed mortgage-holders to pay an unrealistically low rate for a period of time before ‘resetting’ to a much higher, unaffordable, rate.
In addition to this, loans in the US tend to be ‘non-recourse’ meaning that the only collateral that a lender would have on a mortgage is the house itself. In Canada, mortgages tend to be ‘full-recourse’, with many banks demanding personal guarantees. This difference has resulted in people walking away from their homes in the US at a much higher rate than in Canada.
In the end, the result of all of these policy differences means that Canada is fairly well-insulated from the carnage that occurred south of the border. In addition, the Federal government, in coordination with the Bank of Canada, changed the mortgage rules on July 9th to lower the amortization period to 25 years (from a peak of 40 years), effectively making it harder for Canadians to borrow more than they can afford.
Interestingly, our conservative, low-competition banking environment may have saved our housing market from a painful downturn.