CIBC Capital Markets managing director and deputy chief economist Benjamin Tal and PMA Brethour Realty executive chairman Andy Brethour closed the 2022 PMA-CIBC Summit Series of webinars by providing an update on the Canadian economy and its impact on housing.
During the Nov. 25 event, Brethour said Canada has experienced mortgage rates below the current range of six per cent for the past 20 years, making it difficult for many people to even qualify for a mortgage now.
While rates have increased significantly this year, he reminded viewers he had a 21.5 per cent mortgage rate in 1981 and rates were at 11.75 per cent in the 1990s.
Brethour said the market can adjust to a high rate; what's required is stability - the type experienced from July to October when sales and prices remained essentially flat and supply held.
“Stability really is the key factor for consumers saying ‘OK, the bottom, the correction, the adjustment has been reached,’ and they’re now feeling more comfortable about getting back into the market,” Brethour said.
The federal government’s plan to increase immigration to 500,000 annually, for a total of about 1.4 million through 2025, adds pressure on the demand side, however.
While Brethour thinks immigration is good for the long-term health of the economy, he’s concerned the influx will worsen our housing shortage.
Ontario and Canadian government policies
Brethour said there are 750,000 people with student visas in Canada, one-third of them in Ontario, who will be exempt from foreign homebuyer restrictions and taxes if they apply for permanent residency.
The Ontario government is targeting the construction of 1.5 million new homes by 2032 and is pushing its agenda with Bill 23, the More Homes, Built Faster Act, which proposes extensive changes to the policy-led planning and land development system which guides municipalities in the province.
The bill has drawn criticism from municipalities concerned that reduced fees and development charges will impact their ability to provide necessary services, as well as from environmental and rental housing advocates. Brethour is a major supporter of the legislation, however.
He also called for the suspension of Canada’s mortgage qualifying stress test, a tool used to determine if borrowers could meet mortgage payments should they undergo financial strain, or if interest rates rise.
The current stress test rate to qualify for a mortgage, which will be reviewed on Dec. 15, is the higher of 5.25 per cent or a mortgage holder’s current rate plus two per cent.
“It is in a position right now where it's piling on and it's redundant, and it would go a long way to help our industry,” Brethour said of abolishing the stress test.
Tal said passing the stress test was much easier with a variable-rate mortgage than a fixed-rate mortgage and now close to 70 per cent of mortgages are in the former category.
“Now those people are seeing this huge increase in interest rates. So I think that, in a way, the stress test raised the risk in the market by pushing too many people to variables. And I think that if we don't change it, it will shift people to alternative lenders.”
The stress test is a requirement of mortgage lending at most Canadian financial institutions, but not for unregulated private lenders.
Role of the Bank of Canada
Tal reiterated several points he made during his presentation at the Canadian Apartment Investment Conference in September and emphasized the Bank of Canada is more interested in reducing inflation to two per cent than avoiding a recession.
It has been doing this, in part, by raising interest rates.
Tal said every previous housing market crash and economic recession was helped, if not caused, by the central bank raising interest rates by too much. The Bank of Canada most recently increased rates 50 basis points instead of 75 because it had this in mind, Tal said.
There’s demand-driven and supply-driven inflation. The share driven by supply is coming down because of significant supply-chain improvements, increased freight activity and reduced shipping costs.
“The lower the contribution of supply to inflation, the more effective the Bank of Canada is because everything is domestic,” said Tal. “You can do something about it.”
Eliminating or significantly reducing the supply component of inflation, Tal said, will lower the rate by three or four per cent.
He’s optimistic Canada’s inflation rate can be reduced to four per cent in the next few quarters.
The Canadian labour market
There are a million vacancies in the Canadian job market, Tal explained, as COVID-19 has changed its structure.
Almost all jobs created since the start of the pandemic have gone to university-educated individuals, while the people exiting the job market are less educated and leaving lower-paying jobs.
The share of low-paying jobs is going down and wages at these low-paying jobs aren’t going up because the small business owners can’t afford increases.
Tal said Canada is entering a recession, but the damage it will cause to the labour market shouldn’t be significant. He expects unemployment to rise to about 6.5 per cent, but said the economy will shed vacant positions and not jobs.
However, if the supply component of inflation doesn’t decrease, Canada will be in for a more serious recession that will significantly damage the labour market. He gave that scenario a 25 to 30 per cent chance of happening.
Interest rate movement and inflation
The Bank of Canada’s policy interest rate has risen from 1.75 per cent earlier this year to 3.75 per cent.
Tal thinks it could increase to 4.25 per cent in December and he doesn’t believe rate cuts — down to 2.75 or three per cent — will occur until late 2023 or early 2024.
“You want to make sure that inflation is dead before you cut interest rates,” said Tal. “The reason why we had a double-dip recession in the 1980s is because the authorities lowered interest rates prematurely and caused another wave of inflation and therefore a recession.”
Deglobalization replacing globalization, just-in-case inventories replacing just-in-time inventories, a tight and expensive labour market, and greener environmental measures are all inflationary factors to be considered.
These could prevent interest rates from dropping further than 2.75 to three per cent, according to Tal.
Housing demand and prices
Tal believes the housing market will perform well at that level and said the current correction period — which he called a good thing and not a meltdown — is the first where housing supply didn’t rise.
“People don't want to sell,” said Tal. “They want to see when the fog clears and then they will start selling.”
The composite price of housing is down 10 per cent in Canada after rising by 40 per cent earlier in the pandemic when there were low interest rates and a low unemployment rate.
Many homeowners face mortgage payment increases when they renew and there’s concern some may be forced to sell because they can’t keep up, but that hasn’t occurred for the most part to this point.
Tal believes enough new housing will come to the market to prevent prices from rising. Demand will remain strong, however.
The majority of immigrants are settling in Toronto and Vancouver, according to Tal, which is exacerbating the housing crises in those cities.
He would like to see incentives introduced so people will be more willing to spread out around the country.
Brethour and Tal agree much more rental housing needs to be built in Canada.
“We are now going through a reset period,” Tal said. “But, it doesn't mean that this market is weak. This market is extremely strong.”