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Investor-fuelled housing mania puts Central Canada’s biggest cities at risk of correction: Bank of Canada

Kevin Carmichael: Montreal might now be the city most at risk of a downturn in the real-estate market

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Ground Zero of the national housing crunch has shifted to Central Canada’s biggest cities, and excess demand appears to be coming from investors, not households, according to the Bank of Canada’s bi-annual review of the financial system.

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The housing mania that has gripped Canada for more than a decade originated in Vancouver, where the combination of ultra-low interest rates, international money and low supply combined to ignite a real-estate boom that captured global attention, and eventually morphed into an affordability crisis that turned housing into an important political issue.

But demand and supply in British Columbia’s main urban centres has been roughly balanced since the end of 2019, according to the Bank of Canada’s House Price Exuberance Indictor, which combines various strands of housing data to asses whether prices have become “extrapolative,” the central bank’s word for demand explained by an expectation that prices will keep rising, not market fundamentals such as population growth and the rate of housing starts.

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Now, authorities in Ontario and Quebec should be most worried about a housing bust. The Greater Toronto Area, which, to be sure, soon caught up to Vancouver as a troubling source of house-price inflation in the aftermath of the Great Recession, continues to exhibit signs of “exuberance,” as do Hamilton and Ottawa, according to the central bank’s analysis. And Montreal might now be the city most at risk of a downturn in the real-estate market, as it’s square on the Bank of Canada’s heat map went from red over the first half of the year to an even darker red in the third quarter.

Extrapolative price pressures, “can occur when people fear missing out or expect to make future capital gain from reselling, or both,” Paul Beaudry, a deputy governor at the Bank of Canada, said in a speech on Nov. 23. “The good news is that the somewhat slower house price growth that we saw over the summer should lower the chances of undesirable extrapolative price dynamics,” he added. “But some markets still show signs of such expectations.”

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The Bank of Canada’s ability to influence housing prices is often overstated. Higher interest rates would deflate demand, but policy-makers would rather avoid harming the prospects of households and businesses across the country to disrupt excessive speculation in individual cities. The central bank has no regulatory power, so all it can do is use its analytical heft to advise politicians and regulators of the situation.

“It starts at the municipal level,” Christopher Alexander, president of Re/Max Holdings Inc.’s Canadian unit, told the Financial Post’s Larysa Harapyn this week, citing land-transfer taxes, the slow approval of building permits, and local fights over whether cities to build up or continue to sprawl as barriers to accelerating supply. “It’s becoming more and more of a crisis,” Alexander said. “We can’t keep doing more of the same or we’re going to get the same result.”

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In May, when the central bank last reviewed the financial system, it singled out troublesome local markets for the first time, a decision that should make it harder for provincial and municipal politicians to ignore the threat. In the November update, Beaudry added new analysis that shows much of the pandemic-era demand for housing has come from investors and repeat homebuyers; year-over-year growth in mortgages taken out by investors surged 100 per cent in the second quarter, compared with about 60 per cent for repeat buyers and about 40 per cent for first-time buyers.

“A sudden influx of investors in the housing market likely contributed to the rapid price increases we saw earlier this year,” Beaudry said. “In such a case, expectations of future price increases can become self-fulfilling, at least for a while. That can expose the market to a higher chance of a correction.”

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Housing received specific mention in Prime Minister Justin Trudeau’s throne speech on Nov. 23, highlighting the extent to which real-estate prices have become a political issue.

The government cited its campaign pledge to create a $4-billion fund to finance 100,000 new urban homes by 2025 and a separate promise to create a new rent-to-own program as examples of its commitment to lowering the cost of shelter. It also said that it would follow through on a promise to revamp the First-Time Home Buyer Incentive , a demand-side sop that sees Canada Mortgage Housing Corp. help with an initial payment in return for an equity stake in the property. The program adds fuel to the fire by stoking demand, if only marginally, but at least it stops stretched households from taking on more debt. That’s important because the debt that Canadians have piled up chasing rising housing costs remains a weak spot that continues to worry the central bank, especially as it readies to resume raising interest rates from ultra-low levels.

“Vulnerabilities linked to high indebtedness, overall, seem to be rising once more after a brief pause,” Beaudry said. “While Canadian banks are resilient, these vulnerabilities could exacerbate the economic impact of any substantial rise in interest rates or adverse shock.”

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