Update on Canadian Housing

March 26, 2021 | Matt Barasch


This week, we thought we will focus on housing. We will mainly focus on a recent Q&A done with Robert Hogue, who is a Senior Economist with RBC Economics and an expert on the Canadian housing market. If you would like to read the full interview, you can access it here: https://thoughtleadership.rbc.com/hot-canadian-housing-markets-call-for-a-policy-response/?_ga=2.114330119.1603305877.1616339022-610831116.1549371697

Before we get to the interview, let’s start with a chart:

As you can see, home resales in Canada hit 784,000 last month. To put that number in perspective, the highest level over the past 15-years prior to 2020 was less than 600k in any given month. This has led to a sharp increase in prices as demand greatly exceeds supply:

Okay, let’s now turn to the interview:

The main thrust of the interview was to focus on the rapid rise in home prices across Canada and the potential policy measures that the government could undertake to try to cool the market.

Main issues: Demand is very strong and supply is very tight. Further, what used to be mainly a Toronto and Vancouver problem has now become an everywhere in Canada problem. In addition, both buyers and sellers expect prices to continue to rise, which feeds into what is known as FOMO – Fear of Missing Out – which further stocks demand (if I don’t buy this now, prices will be even higher in a year, so I better buy it now).

Should policymakers do something about it? Hogue thinks so as an overheating housing market is a threat to the economy should it destabilize. He believes the current market is similar to the market of the late 1980s, which was the last time the Canadian housing market had a significant price correction. Further, an overheating housing market exacerbates the divide between the haves and have-nots.

What should policymakers do about it? Hogue brings up several measures the government should take to increase new supply of what he calls “medium-density, family friendly housing.” But he also thinks the government should consider rolling back some policies that have been in place for decades with the biggest potential game-changer the so called “sacred cow” - the principal residence exemption from capital gains tax.

While Hogue does not go into any more detail on this, it is something we have discussed with various economists and strategists in Canada. It is unlikely that the government would do away with the capital gains exemption on principal residences in its entirety, but it is possible that they could make some adjustments. These adjustments could take many forms, but we would summarize them as this:

  • Potential cap on tax-free gain – the government could cap the exemption – say at $1 million – and then gradually phase in an inclusion rate similar to capital gains inclusions on equity capital gains. So, for example, the first $1 million gain is tax free, the next $1 million carries a capital gains inclusion rate of 25%, anything above $2 million has a 50% inclusion rate.
  • Potential holding period exemption – the government could exempt any properties owned for more than a certain number of years from capital gains, but any properties bought and sold within a shorter window would be subject to capital gains tax. This would have the benefit of slowing the flipping of properties. So, for example, any property owned more than 10-years would be exempt, any property held 5-10-years would be subject to a 25% inclusion rate and any property held less than 5-years would be subject to a 50% inclusion rate.
  • Potential grandfathering of gains – basically, the government could start the clock from a set date – so anything purchased after a certain date would be subject to capital gains tax, but anything purchased before that date would not. So, for example, any property purchased prior to 2020 would be exempt, but any property purchased in 2020 and beyond would be subject to some tax.

We would note that the capital gains exemption is very much a political hot potato, so we would expect the politics of this to be challenging should the government seek changes.

How does this end? While this question was not specifically part of the interview, we lifted the following from RBC Economics most recent comment on Canadian housing (March 15, 2021):

“Signs of overheated market conditions of course raise the risk of a price correction down the road. Our base case scenario, though, remains that prices will continue to appreciate in the year ahead, albeit at a slower and slower pace as we get closer to 2022. A creeping-up of longer-term interest rates, deteriorating affordability, the resumption of office work and possible policy intervention will eventually cool homebuyer demand and set the stage for a soft landing. We think modest outright price declines could be in the cards over the medium term, perhaps by the latter stages of 2022 when interest rates rise more broadly.”

Thus, we would note that while RBC Economics has some concerns, their base case remains a “soft landing”.

Final Thoughts: We are skeptical that there will be a major pricing downtrend in the Toronto area as demand is likely to continue to outpace supply, especially with immigration likely to resume as COVID moves to the rearview mirror. We do have some concerns about the condo market, which has been less frothy, as there is an excess of supply and demand remains tepid. Areas outside the GTA and other major cities (Vancouver mainly) are likely more vulnerable, as they do not enjoy the same immigration influx and thus demand and supply are likely to balance more quickly. One area of the market that we will be fascinated to watch is cottage country, as both sales and prices have skyrocketed during COVID. A good portion of these buyers are likely new cottagers and we will be interested to see how they feel about their purchases 2 or 3-years from now after they have spent most of a Friday or Sunday sitting in the parking lot also known as the 400 highway.