Economic Letter

David Bond is a retired bank economist who lives in Kelowna.

Occasionally, I buy a Saturday edition of a Vancouver paper just to see what is happening in the city where I lived, off and on, for over 20 years.

Out of curiosity, I look at the real estate ads and cannot believe the prices. What I would consider a modest family-sized dwelling with perhaps three bedrooms and two baths is listed for more than $1.2 million! Most of the houses are going for more than that.

A million-dollar house bought with a minimum down-payment of $200,000 (that is what is required for a house costing $1 million or more) with a 2% mortgage will have a monthly payment of $3,388 or $40,656 annually.

Add to that municipal taxes of, say, $4,000 (a low-ball estimate) and insurance of $2,000 plus some minimal expenditures for maintenance and heating (at least $2,000) and the annual expenditures will exceed $48,000. Remember, this is in after-tax dollars.

The most recent income figures for Canadian households (2019) put the median single-earner income at $62,900 and median household income (which assumes a family unit with two or more related income earners) at $111,000 — and these numbers refer to pre-tax income.

That means from 43% to 76% of gross family income has to be dedicated to housing. Most advice relating to drafting a family monthly budget suggests that the cost of housing should be no greater than 35% of net after-tax income. So, it is easy to see that, for most people, buying a home in Vancouver is well beyond their reach.

What has been happening in most major cities in Canada — but particularly in Vancouver, Toronto, Montreal and Ottawa —is that housing prices are continuing to rise at about 10% per year and in the last quarter alone rose by 2.8%. Total number of sales for 2020 rose by 12.6% over 2019 and in December 2020 monthly sales were up 47.2%, year over year. 

Put another way, the market for housing seems to be experiencing a boom that may be fuelled by panic buyers. These buyers believe that mortgage rates will rise sharply in the near future so it’s better to buy now — even at inflated prices — to avoid being shut of the market later when it might be significantly more difficult to qualify for a mortgage. It’s not clear these buyers are looking carefully at the cost of carrying the mortgage and maintaining the property in the longer run.

The problem with this type of market is that it is likely to suffer a strong correction — meaning a sharp decline in demand and falling prices — if interest rates rise precipitously.

That could leave a sizeable portion of recent home buyers with mortgages greater than the market value of their homes. Trapped in cases where asset values are less than corresponding debts could lead to personal bankruptcies and sizeable losses for financial institutions.

So, the challenge is how to dampen the panic buying. Normally a sizeable uptick in the costs of mortgage loans would do the trick. But Canada is just starting to recover from the adverse effects of COVID-19 so raising interest rates is the wrong thing to do.

An alternative would be to increase the transaction taxes on the selling price, such as was done in the case of the foreign buyers’ tax. But the market is currently dominated by domestic buyers.

Some have suggested making previously tax-exempt profits on the sale of principal residences subject to a capital gains tax that would decline in size the longer the home had been held by the seller. This discourages speculative buying. 

The creative intervention I favour is mandatory transparency in the bidding by buyers. 

Currently many homes are selling at a premium over the asking price but those making those bids have no idea what others have offered. In such cases, panicked buyers may be motivated to offer substantial premiums in order to “win.” 

Publishing the highest existing offer with a firm at closing time would instantly bring about a more rational market.

Of course, the regulator could simply raise the minimum down-payment, but both the government and the banks would suffer significant blowback.

David Bond is a retired bank economist who lives in Kelowna.