The Bank of Canada has not yet declared victory over inflation. While we are likely close to seeing the first rate cut by the central bank, potentially as early as June or July, the market remains in a state of suspended animation, facing numerous challenges:
- Housing prices, although off their pandemic highs, remain elevated and are expected to increase further. The Canada Mortgage and Housing Corporation (CMHC) is forecasting that home prices could return to the peak levels seen in early 2022 by next year and reach new highs by 2026. With interest rates at their recent highs, housing affordability has decreased significantly.
- Sales of existing homes are depressed and sitting at their lowest levels since the global financial crisis.
- Buyers are waiting for prices to fall, while sellers, for the most part, are holding off listing their homes as they wait for market conditions to improve.
- The market is stuck; prices are not falling. High mortgage rates have reduced demand, but the severe undersupply of housing relative to the population presents a problem that won’t be quickly solved.
The trifecta of high prices, high mortgage rates and a shortage of supply has led to the current affordability crisis.
Can rising incomes help restore affordability?
A common theme in discussions around affordability is the idea that the housing market can return to a more “normal” state if house prices drop enough to “clear” the market and start a new cycle. While this is certainly a possibility, it would likely require a recession and significant job losses across the economy, which we do not anticipate occurring in the next few years.
While existing homeowners and prospective buyers would like to see lower mortgage rates, this will only be part of the puzzle. Homebuying is typically motivated by life events such as marriage, relocating for a new job, having children, or retirement.
Without a significant drop in home prices, income growth would be necessary to restore affordability. However, returning to the affordability levels seen around 2016 would require unprecedented levels of employment income growth. Given our poor level of productivity, this is not in the cards. Higher income growth would help, but it will not solve the affordability issue in the near or medium term.
What about lower rates?
Lower rates will certainly benefit borrowers, especially those who already have a mortgage and are facing higher rates when they renew and/or refinance over the next few years. For new homebuyers, however, lower rates are likely to lead to higher property prices as more buyers move off the sidelines and enter the market.
Will the federal government’s housing strategy be the solution?
Focusing on encouraging new housing supply is helpful, but the current emphasis on rental supply, while addressing part of the problem, overlooks the challenges of increasing home ownership. Most of the projects being encouraged have long project cycles, meaning their impact won’t be realized for five to seven years. In contrast, encouraging secondary suites and accessory dwelling units could have a more immediate effect. However, if the federal program is modeled after the BC program (as we expect), prospective landlords in markets like BC and Ontario are unlikely to participate as they will have little control over tenancy.
What is the solution?
New housing has become a cash cow for all levels of government. According to a study by CANCEA, the tax burden on new housing is 31% of the purchase price. The federal government is the largest beneficiary, receiving 39% of this revenue. While it does invest in provincial infrastructure, the gap between taxes collected and investments made is significant. CANCEA argues that the federal government must increase its involvement in funding relevant public infrastructure. At the provincial level, provinces like BC and Ontario need to reassess their development charges and explore alternative municipal financing models that provide a more equitable tax burden. Although this could lead to higher property taxes, current incentives encourage politicians to place a larger portion of the tax burden for infrastructure on new housing to keep property tax rates low. A more transparent tax system would help balance the burden and encourage a more thoughtful municipal spending process.
Independent Opinion
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