The Bank of Canada to increased rates at its decision meeting on Wednesday, July 11th. The central bank increased its key rate to 1.5 per cent from 1.25 per cent.
The forces that favoured an increase in the cost of money outweighed those that supported continued loose money policies. The Canadian economy remains in very good shape. Inflation hasn’t reared its ugly head, household consumption is neither increasing recklessly nor falling precipitously. Growth and unemployment figures are very positive. Lack of price growth dynamism in the real estate markets, trade issues with the United States, and high levels of private and public debt are the key structural problems. Weighed against one another, the balance skews toward a rate hike.
Central Banks Around The World Are Adamant.
Central banks have begun and will continue a long term policy plan of ever higher rates, and more scrutiny on international banks and financial institutions. The Bank of Canada is no different. The key facts that most worry senior officials, politicians, and Central Bankers are the enormous levels of household and government debt, particularly mortgage debt. A generation of historically unprecedented record low interest rates has blown up large debt bubbles which elites are now desperate to deflate as carefully as possible.
Rates Hike To Negatively Impact Consumers
The likely hike will no doubt have a negative impact on consumers and on the real estate market. Banks are likely to raise their mortgage rates in response. The debt to disposable income ratio in Canada has hit a record of almost 175%, much higher than in the United States before the start of the Great Recession. A rate hike will be of no help to those looking for high prices for their real estate holdings. Debt to income ratios for the poorest Canadians are especially high. The lowest quintile of earners average a debt ratio of almost 350%. While higher rates will come at a cost, many believe they are absolutely necessary, and few doubt they are avoidable.
The Bank of Canada was generally expected to raise its benchmark interest rate from 1.00 to 1.25 this week, but decided to hold its rate at 1.00. The Bank cited strong economic growth and the desire to moderate its pace of rate increases so consumers and the economy can better adjust to more expensive money. The Bank’s decision was met with interest as many expected it to stick to its aggressive rate hike pace. Many, however, believed the bank would hold off as surveys and media coverage showed that consumers were weary about the speed of interest rate increases and were worried about their ability to service the increased costs.
The immediate market reaction saw the dollar fall 0.65 cents and the TSX drop 60 points. Investors reported their view that the interest rate holding would lower economic growth for next year. Market watchers will take mixed views. Those in the real estate sector will cheer, as new taxes and stress test rules recently implemented will inevitably serve as a disincentive for builders to construct new homes and for buyers who are already under tremendous scrutiny from banks and insurers, especially first-time buyers.
The decision to hold shows that the Bank is concerned about excessively pressuring the real estate sector, given the new stress test rules will add cooling effects to an already lukewarm market at best. The Bank is likely to keep a close eye on inflation, GDP figures, and job numbers in the coming weeks and months before deciding to raise rates again in the next quarter. Fundamentally, the international trend is focused on raising rates, increasing the cost of capital, cooling consumption, and adding space and breathing room for central banks to decrease rates in any future economic challenges.
The Federal Reserve is the Central Bank of the United States. Like the Bank of Canada, the Federal Reserve, known as the Fed, manages the U.S. dollar by determining interest rates, and controlling the money supply (regulating the amount of money printed or injected into the system). The Fed also has significant regulatory powers – having a great deal of power in inspecting and administering American commercial and investment banks. It plays a significant role in determining capital reserve requirements (how much money banks keep on hand), and keeps an eye on banks to ensure their activities do not harm the U.S. and international financial system; largely to prevent a repeat of the 2007-8 crisis.
The Fed is the most powerful central bank on the planet by far, and plays a massive role in influencing the global economy and broad economic and financial trends. For the last decade, it led the way and began the international trend of lowering interest rates, printing money to inject liquidity into the international financial system, and loaned commercial and other Central banks trillions of dollars to keep them stable, functioning, and healthy. This Wednesday, Federal Reserve Chairwoman Janet Yellen announced that the Fed would no longer continue its policy of quantitative easing (money printing and asset buying) to support the credit and financial markets. It also sent strong signals that its decade long policy of low interest rates, easy money, and loose credit is fully and totally ending.
The Fed will likely raise rates one more time before the end of the year. The effects of these announcements are very important for Canada and the southern Ontario real estate market. The Bank of Canada almost always mimics the Fed’s actions and follows in its footsteps, as do other Central Banks because of the weight of the U.S. dollar and the size of the U.S. economy. The Bank of Canada has already bucked the Fed and is raising rates faster than the Fed. But the announcement that the Fed will no longer continue its loose policies will only encourage and reinforce the emerging trend by Bank of Canada (BOC) Governor Stephen Poloz in making money more expensive and in increasing interest rates.
A recent report by the Bank of International Settlements in Switzerland (BIS), the “central bank of central banks”, indicates that some members of the BIS believe that higher interest rates will now become the new norm and that the firm orthodoxy of easy money is now truly and completely, a thing of the past. The great international financial institutions of the world are moving to make money more expensive, and in the long term this will mean higher and higher mortgage rates, and less flexibility for our already Conservative banks to approve new mortgages.
Despite a fall in sales and a slowdown in prices, the fundamentals underpinning the Toronto housing market remain strong. The impact of a recent rate hike and a slew of measures at the provincial level, largely a 15% foreign buyer tax, have cooled what was once the most dynamic seller’s market in GTA and Southern Ontario history. New data released shows two important trends that underpin the stability and long term strength of the GTA housing market.
The first is that mortgage delinquencies are now at a record low and continue to fall. Data released by Equifax Canada shows that mortgage delinquencies have been falling in Canada, and large banks, like TD, report extremely low rates of default and delinquency. Another important and positive statistic has been the fact that home building has now been found to exceed demand in Toronto. For many years, industry groups, real estate professionals, and some politicians and economists have complained that not even housing stock was being built and that the government should be providing more incentives for builders to develop.
Recent data shows that between 2011 and 2016 there were 146,200 new households in Toronto, compared to the 175,825 homes that were built. This shows that housing supply exceeded established demand by over 30,000 units. While the supply of single detached homes in Toronto remains largely fixed due to space constraints, the latest census data shows that home supply has kept pace with home demand for many years. This proves that the GTA real estate market is adept at responding to the signals of demand and supply.
While having decreased month over month marginally, prices in Toronto are still significantly higher today than they were a year ago. The condominium market is on fire in Toronto, with double digit price and sale increases recorded in the last few weeks. Many realtors are predicting that the double whammy impact of a 15% foreign buyer tax and a small interest rate hike will temporarily cool the market before it heats up again, as was the case in Vancouver. Overall, the Toronto housing market remains rock solid.
As our nation celebrates 150 years of straddling the world’s stage, Tembo has decided to prepare a blog outlining how important the real estate sector has become to our national economy and prosperity.
Historically, the bedrock of the Canadian economy has been primary resources. The cycle has been simple. A resource is discovered or harvesting begins, within a short period of time extraction then begins to boom. The boom provides wealth and opportunity and attracts migration, and then the process matures, the resource declines in value or is depleted or made obsolete by market changes: thus paving the way for a new staple to be collected. The first of these resources was Atlantic cod in the 15th century, then fur and pelts, then lumber, and eventually, minerals and oil by the end of the 19th and early 20th centuries.
By the end of the Second World War, the Canadian economy began to aggressively industrialize and the service sector began to grow expansively. Suburbia sprouted and real estate began to boom and grow as a major sector. From the late 1970s to the present, the post-war industrial components of the economy have gradually withered away. Manufacturing has especially declined in southern Ontario, due to higher costs, relentless foreign competition, and a decline of productivity and innovation.
High oil prices from 2003-2015 helped the economy boom, but as those prices collapsed real estate has taken oil and manufacturing’s place as the main economic engine for the country. Statistics show that most of the strong economic growth the country is currently experiencing comes from four major sources: finance/insurance, real estate/rental/leasing, construction, and professional/scientific, three of these four are real estate related. Manufacturing, farming, fishing, and forestry were sources of economic contraction. Without real estate, Canada would be in a recession.
Businesses are pouring money into real estate and new construction is soaring, while renovation activity is also growing strongly. Increases in housing wealth and home equity are also prompting consumers to borrow more money, spend more, and even leverage the purchase of vacation homes or homes for rental income and investing. Real estate has become so robust that recently, the national housing agency, the CMHC (Canada Mortgage and Housing Corporation) declared it would transfer a special $4 billion dividend to the Federal Government over two years. Soaring property transfer and land taxes are one of the main reasons the deficit prone Ontario Liberal government recently tabled a balance budget for the first time in over a decade.
Overall, the importance of construction, housing, and its financially related business has never been more fundamental to Canadian governments, consumers, and households.
In this blog post, Tembo Financial will outline some of the main underlying foundations of the real estate market in the Greater Toronto Area. These foundations are the key pillars of strength, resilience, and health in our housing market.
Low rates: The Bank of Canada has interest rates set at 0.50% and there is no intention from the Bank to raise rates anytime soon. Inflation in Canada is at record lows and has been decreasing so there is little pressure on the Bank to raise rates.
Stable economy: Unemployment in Ontario is at 5.8%, the lowest level in over 16 years. Jobs are plentiful, consumer spending is strong, and there are several sectors which are growing quickly, particularly technology, advanced services, and finance. Governments are spending large amounts of money to support the economy and construction and development is widespread. Real estate in Ontario has always remained strong with unemployment at present levels.
Immigration: A strong economy and society are inviting for immigrants, especially when one considers the present situation in Europe, the United States, and the Middle East. Record numbers of immigrants are entering Canada, and many of those migrants who have already lived in the country for some time are now buying housing and moving out of rentals. Net immigration will hit 350,000 a year for the foreseeable future. These new Canadians will need housing in the short, medium, and long term.
The Greenbelt: The Greenbelt is a massive tract of protected greenspace on the edges of the Greater Toronto Area that is blocked from housing development to preserve farmland and protect the environment. This has restricted supply, driven up the costs of land and thus of housing, and will stimulate other sectors of the real estate industry, particularly high rise condos and rentals.
Better regulations: The number of high risk, high debt mortgages in Canada is much lower than was the case in the United States a decade ago. While the cost of money is low, buyers need good jobs, solid credit, and fairly large deposits to secure mortgages and ultimately close a house purchase. Canada has been internationally recognised as having a strong regulatory system in place with regards to housing and mortgage issuance.
Stellar banks: Canada’s big five banks are widely regarded as some of the best run, most successful, and most profitable in the world. Our banking system operates under much more stringent regulatory system than many of our counterparts. Our banks are healthy and growing and were not bailed out by governments as was the case in the UK and the US. Canadian insurance companies are also financially solid and growing.
In combination, these five pillars have contributed to the most dynamic sellers’ market in the history of southern Ontario. Tembo Financial has great confidence in the long term health of the GTA housing market.