Growing Pressure to Cut Rates

Senior economists from CIBC are making bold predictions on where interest rates will be going. They predict that the BOC will cut rates by 25 basis points next year, in lockstep with the Fed. This would see rates fall from 1.75% to 1.50%, if current rates hold. The rationale for the expectation of a cut follows weakening economic data, slowing growth, and a significant trade and account deficit. Banks have also reported financial data which shows Canadian contributions to their bottom lines seeing little to no growth, with the bulk of profit growth coming from U.S. assets.

In addition, pressure over mortgage stress tests has many believing that lower rates are necessary to give hope to the tens of thousands of prospective home buyers who have now been squeezed out of the market permanently. But the real overhang on this file has been the growing chorus of voices across the border which are demanding that the U.S. Federal Reserve cut rates, pump up the economy with more quantitative easing, and more efforts to stimulate a stagnant U.S. economy. The originator of much of this pressure has been Donald Trump himself. Trump’s language of criticism against the U.S. Fed and Fed Chair Jerome Powell has been consistently scathing for some time now.

Several days ago, the President tweeted that the U.S. stock market and economy would reach even higher levels if the Fed ‘did what China is doing’ by lowering rates and making the U.S. dollar cheaper in relation to competitors to boost exports. He also claimed that the Fed has ‘consistently been raising rates’ on his watch, seeing it as discriminatory. He also has stated the view that the stock market would reach record highs if the Fed lowered rates. At first, many called Trump’s language unprecedented and authoritarian, but now economists, market watchers, and business leaders are echoing his criticism of the Fed and are urging it to supercharge the U.S. economy so it can better compete with China. Lower interest rates are on their way. 

On Money Laundering and International Property Ownership Laws

On Thursday, May 30th, the federal government revealed it had found over $1 billion in new tax revenue. Where did the Feds get the money? From real estate. Four years of drawn-out, complicated CRA audits saw almost 42,000 files reviewed in the key housing markets of B.C. and Ontario. The results netted over $100 million just in penalties based on flimsy tax compliance done in real estate transactions. The Feds are doing what they can to shake this ‘money tree,’ and have allocated some $50 million in additional spending to further these audits and to root out more non-compliance. This is on top of hundreds of million of already announced investments in the CRA which started four years ago, all aimed at rooting out tax dodging and generating more revenue for Ottawa to spend without raising taxes. 

 

Canada has established itself as a one of the real estate money laundering hotspots of the world. Some $50 billion was laundered across the country in 2018, with just over $7 billion laundered just in B.C. This is a very rough estimate, as it is impossible to put an exact figure on all of the washed monies. This represents a drop of the many trillions of dollars of ‘dirty money’ floating around international markets. Canada offers anonymity to real, or ‘beneficial’ real estate owners, just like notorious tax havens like the British Virgin Islands, the Isle of Man, or the Seychelles. We are recognized for some of the weakest money-laundering laws in the world. And the truth is, our economic stability and quality of life depend on washing dirty money. Without it, the real estate lobby, the big banks, and governments across the country would be starved of business, capital, and revenues to spend. We’re all complicit. 

 

Canada is one of the few countries in the world where there are virtually no restrictions on foreigners buying real estate here. The system depends upon an openness to foreign capital and as many high value transactions occurring as possible. In rapidly growing Thailand, for example, it is almost impossible for a foreigner to own a controlling stake in land or housing. There are very few ways to get around Thai property rules, so Canadians who’d like a beach house in Thailand have to jump through many, many hoops to pull off a buy. In New Zealand, previously lax rules for foreign ownership are being tightened and New Zealand government was elected in 2017 on a campaign of restricting foreign ownership. Prime land in our country is open for their world to buy. 

A Recovery That’s Gaining Steam

The latest stats are out and they’re very good for Toronto real estate. Sales last month rose by 19% from May 2018 figures. The number of transactions almost hit 9,900 and are approaching more robust historical averages. Home prices also went up by 3.5%, higher than inflation, and condo prices shot up 5%. The average home price in Toronto is now $838.5K, and the average condo price is $590K. Detached housing prices increased by only 1% to $1.042 million, but were marked by a much lower inventory and number of transactions, thus dampening dynamism.

Prices for condo townhouses are growing at the fastest pace, with a 6% increase recorded last month. Their combination of being relatively affordable and slightly more spacious than traditional condos has afforded them a great deal of attention with prospective homebuyers. Overall, new listings barely grew, and real estate experts claim that there is little capacity for this figure to expand, so further increases in prices and demand are anticipated – especially is sales continue to recover. If we have more positive months like May, expect price growth to rapidly rise once again. To put this very positive month in perspective, the market has now returned to the levels it was at shortly before the introduction of stress tests. This shows how strong the underlying fundamentals of GTA real estate are. 

While we have a long way to go before we see prices and demand for detached houses reach the dizzying levels of March and April 2017, semi-detached and condo townhouse figures are almost at their Spring 17′ peaks. Condo apartment prices almost never fall in Toronto, so positive trends for a quarter or two should get numbers to meet Spring 17′ peaks as well. The $1.2 million average detached home price levels which marked Spring 17′ are a long ways away but not impossible to revive. GTA monthly unit sales reached a high of almost 13,000 in mid 2016, and at the beginning of 2019 were barely at 4,000. If trends continue we should see a few more months of rising sales. Keep in mind that there are growing rumours of an incoming BOC rate cut, in addition, Canada’s big banks will likely work to revive growth in domestic credit and mortgage operations, so incentives and lower rates may be well on their way!

Have You Ever Heard of Section 37?

Planning law and regulation in Toronto and the province is complicated, cumbersome, and difficult to understand. It is overwhelmingly written by Queen’s Park, given the Constitutional arrangements in Canada which afford provinces so much legislative punch and power, especially in comparison to regional and municipal governments. Planning law reviews do occur on a routine basis and everyone has their own opinions and views on the state of the overall system and on what should be reformed. One interesting component of planning in the region is Section 37 – which refers to a section of the Ontario Planning Act. 

Section 37 is a clause which gives municipalities, through local Councillors (elected politicians), the power to negotiate changes to planning and zoning in exchange for monetary commitments to certain arbitrary projects. For example, let’s say you’re a developer with a fair bit of cash and you want to build a 30 storey condo in an area where zoning says 20 is the max. You’ve got access to a deal to buy a plot of land for a decent price, now want to make some profit, but calculate that a 20 storey building won’t net you the kind of proceeds you want. So, what do you do? Well, you activate S. 37 and ring up your local City Councillor.

Negotiations start. The Councillor hears you out and thinks what you want is not too unreasonable – it’s only a few extra storeys. What’s wrong with making money? Now in exchange for the immediate zoning change for your extra 10 storeys, the Councillor wants you to scratch his back. You see, he wants to get re-elected, and there’s a neighbourhood where he didn’t get as many votes in the last election that he could use in the next. He wants you to promise $250,000 to upgrade a park in his tricky neighbourhood. You say sure, why not, and the deal is done. Under Section 37, the commitments to projects in exchange for zoning changes are designed to be used to help the community add resources in needs in exchange for the heavy duty development changes. If a developer builds a 60 storey condo instead of a 20 storey condo, the impact on roads, sewers and local schools will be massive.

Councillors have huge power to negotiate these deals for their own political ends and the Section 37 system has come under serious scrutiny in recent years, especially under now deceased former Mayor Rob Ford. With the planning system undergoing massive reforms by now Premier Doug Ford, expect Section 37 to be changed thoroughly.  

Thaws, Rebounds and Real Estate Leaders

In our last blog, Tembo expressed optimism and positivity over the latest real estate stats in Toronto. Sales did well in April, and the amount of listings of new homes rose sharply.

 

Analysts were particularly optimistic over the rise in prices, which went up for two consecutive months. This combination of successively positive data suggest a healthy underlying market and the potential for growth and opportunities over the summer. Toronto’s market continues to dominate Canada’s housing sector, with almost as many homes sold in our city as Montreal, Calgary, and Ottawa combined. Positive expectations for increased demand, sales, and higher prices over the next few months are not without merit.

From May 20-23, Toronto will host Collision, one of the pre-eminent technology and AI Conferences in the world. One of the highlights of this Conference has been the focus on the growth and dynamism of tech. job growth in the city. Over the last 5 years Toronto has created more jobs in the tech space than any other urban area in North America, including mighty Silicon Valley. All of these young tech. professionals will need quality housing in the city and the amount of FDI (foreign direct investment) going to tech is expected to grow ever more rapidly in the next few months and years. This will be a big boon to housing. Economic growth in the city is projected to continue growing in real terms (above inflation), and immigration is growing, not slowing. These two macro trends suggest overall demand will continue rising.

On a final note, Toronto’s leadership in the real estate space continues to be cemented internationally. The biggest real estate company in the world is Brookfield Asset Management. It leads all of its peers in sales, amount of assets, and is extremely competitive in terms of the profits it generates. Separately, the volume of condo projects being built in Toronto and the GTA continues to build up. Chinese developers are building major condo towers in Scarborough, Newmarket is seeing its first major condo development in over 30 years, and Peel Region continues to see the ambitious condo projects underway. 

Ontario’s Housing Revamp Bill 108

The Ford PC government has unveiled a major piece of omnibus legislation designed to promote the construction of new housing and to reform planning in Ontario.

The bill is being passed swiftly by the government, as is the case with most legislation the PCs have introduced. The bill has received a fair bit of media attention and both praise and criticism. One of the key elements of the bill is that it eliminates the two stage appeal process of broad planning reform legislation brought in by the previous Liberal government – returning to a single hearing system. Marking a return with the bill is some of the old powers of the Ontario Municipal Board; namely the return to a single hearing. 

108 also reforms the section 37 system. Section 37 received a considerable amount of attention under former Toronto Mayor Rob Ford. The system allows municipalities to arrange special contributions and payments from developers in exchange for variances and changes to zoning and planning rules. The late Mayor Ford believed the system allowed City Councillors to amass pork barrel spending accounts to spend on parks and other amenities while accommodating powerful and wealthy developers and saw it as a corrupt and inefficient system. Most Section 37 money is accrued in the development heavy downtown core and benefits largely left-wing Councillors and politicians. 108 replaces certain provisions of Section 37 with a new community benefits charge and allows the province to exempt certain types of development from the charge. This reform will intensify provincial activity and interest in municipal and local development matters.

Bill 108 also cuts down on timelines for municipal processing of applications from 180 days to 120 days. It also limits witness activity in an appeal and restricts third party appeals to sub division planning and proposals. All of these changes will speed up development, benefit developers, and restrict the capacity of individuals to challenge construction. These are but a few of the changes Bill 108 makes to the system. The province has also expressed its desire to work with a wide variety of stakeholders and partners to get more housing to market. 

On an Interest Rate Cut

For almost a year, Tembo has repeated a consistent and simple message. Our view was that the Canadian economy relies massively on low interest rates. Higher rates would cripple our nation’s real estate sector, its financial industry, and would raise borrowing costs on strained small and medium sized businesses. Higher rates would also force government across the country at all levels to cut spending and rein in their large deficits. But we also acknowledged that too much easy money for too long a time would weaken the economy, overload it with debt, and incentivize speculative economic activity.

We foresaw that rates would rise rapidly given recent trends as central banks wanted a healthy interest rate cushion in case of a recession. They did. 

 

And then, just as Tembo predicted, the BOC backed off. Weakening post-Christmas spending activity and a stagnant real estate rebound in early Spring unleashed a torrent of sub-par economic data. That, coupled with a topsy-turvy global macroeconomic and political situation, spooked not just the BOC, but Central Banks around the world. In the U.S., Trump and his Chief Economic Advisor Larry Kudlow berated the Fed for its higher interest rates and its wind down of monetary stimulus. Their sharp criticism forced Fed Chair Jerome Powell to participate in a rare interview where he expressed the view that he could not be fired.

 

Now, media reports and rumours are spreading outlining the growing possibility of the Fed cutting interest rates by half a percent and intensifying asset purchasing and macroeconomic stimulus. If such a move would occur, the BOC would effectively be boxed in to cut rates here at home as well. A rate cut in Washington would likely raise the value of the Canadian dollar to the benefit of Canadian consumers. But, the growing rumours, if materialized, would mark a potent change of course and policy. How quickly times change. 

On the Return of Low(er) Interest Rates

It’s back to the future time in Canada. The steadily higher interest rate trajectory that was to be the new normal now appears to be officially dead and buried. With the U.S. Fed signalling an end to higher interest rates and trumpeting its newfound zeal and preparedness to accommodate markets, the BOC had no choice but to emulate.

The BOC’s head body, the Governing Council, made the point that an “accommodative policy interest rate continues to be warranted.” The BOC made its point about the need to keep rates stimulative at the same time as it cut its GDP growth forecast for the national economy to 1.2% from 1.7%. Canadian bond yields and the dollar both fell in response to the news. The clarity of the BOC’s words are striking and diametrically opposite from its firm and disciplined messaging when it repeatedly made the point that it needed to raise rates not long ago. It also suggests that there is an anxiety with monetary policy heads and a perception that the economy increasingly requires propping up. 

 

In Tembo’s opinion, the BOC’s announcement is extremely important for all Canadians and particularly for mortgage holders and prospective home buyers. This announcement from the BOC is strong positioning for stimulus, lower rates, and potential buying of stocks or securities to boost prices, reinforce demand, and service the financial sector. 

 

The implication of this announcement outlines the incoming reality of lower rates, cheaper mortgages, and the BOC reinflating the housing bubble back to more dynamic levels. Canadians should prepare for tighter finances to be safe but should also expect money to become cheaper in the months to come. 

Big Housing Projects and the Benefits of Rapid Transit

In the last four decades, major infrastructure projects in Toronto and the GTA have been few and far between. We have fallen behind. The last two major subway lines that were built benefited low density inner suburbs in North York and Vaughan.While these areas are undergoing building booms and seeing density rise, the lack of a completed downtown relief line is overwhelming Toronto’s subway system. Nonetheless, the Eglinton Crosstown is a project nearing completion that is looked upon more favourably by transit and infrastructure experts. 

 

The Crosstown will provide top notch transit service to the city’s dense and heavily populated midtown area. One major benefit of this massive project is the development and rejuvenation of housing where it is needed most. One such project has received favourable attention; the Crosstown planned community by Aspen Ridge on the corner of Eglinton and Don Mills Rd., just north of the Ontario Science Centre. Right on the Crosstown subway line, this housing project will feature almost a dozen high-rises, townhomes, and low rise buildings. It will also feature considerable green space, restaurants, and rec facilities. This kind of broad, dense, and all-in-one is made possible by the construction of major public transit projects.

 

With recent transit announcements showcasing the desire to pour tens of billions of added dollars into public transit lines in Toronto, projects like the Crosstown community will become more frequent. The 60 acres of the Crosstown community previously consisted of low rise office and warehouse buildings, largely owned by the international tech company Celestica. 

The First Conservative Ontario Budget in 15 years

This week, the new Ford PC government released its first budget. The document outlines a new vision for the province and sets of the government’s fiscal strategy for the next few years. Contrary to the views of many, the budget did not implement massive cuts. Healthcare and education spending will be increasingly modestly, spending for most other areas will either rise extremely modestly and will be effectively frozen over the next few years. When adjusted for inflation, most departments and Ministries will see their budgets cut.

 

The province’s headline announcement is transit related. Premier Ford wants to see a number of new public transit lines built, including a 3-stop Scarborough subway, a subway to Richmond Hill, a downtown relief line from the Science Centre to Queen St .East westward to Ontario Place, a transit line along Sheppard Ave. East, and a subway across central Etobicoke. The province is setting aside over $11 billion to the construction of these lines and expects the federal government and the regional municipalities involved to foot the rest of the project $28 billion cost of these projects. If completed, these lines will have enormous implications for densification, land values, traffic, and economic growth. But massive public transit plans have been announced by provincial governments of all political stripes repeatedly over the last 40 years, and few projects have actually been completed.

There were few mentions of housing, housing affordability, or real estate; these announcements are likely to come later given recent reviews of the industry. There will be a new child tax credit for parents which is quite substantive. Overall, the budget is transit focused and seeks to maintain spending at levels where they are presently.