Since 2008, the housing market has been in a volatile state in Canada’s economy, and the climb back from the financial crisis and oil price shock has been unstable at best. Canadian cities, mainly, Vancouver and Toronto have witnessed prolonged periods of housing price increases, much of it due to foreign investments and defaults on housing loans. On October, 3, 2016, Finance Minister Bill Mourneau announced that the government will be introducing new legislation that will result in a major overhaul to Canada’s mortgage and foreign-ownership rules for real estate.
The government introduced substantial changes to Canada’s housing market that is believed to offset risks within the financial system. Firstly, the government will expand stress tests to all insured mortgages to avoid being on the hook if a borrower defaults on payments. This stress test will be used by the major banks to assess potential buyers’ ability to repay their mortgages against the highest interest rates posted by the Bank of Canada. This requirement, already in place for potential buyers who are referred to as high ratio mortgages, is for borrowers with small down payments and borrowers who borrowed money for less than a five year term. As of October 17, all borrowers must successfully pass this stress test.
Secondly, the government introduced measures to close tax loops that foreign investors use to claim exemptions on their principal residence as capital gains. To tackle this problem, the government now requires all home buyers to file taxes in Canada as a resident in the same year they buy their home in order to claim the capital gains exemptions. This measure is meant to stop and prevent foreign investors from buying properties while overseas and then flipping them for larger profits.
In a prepared statement, David Cramer, a Toronto accountant states “I expect this will start to put the brakes on people who think this is a free way to make money….In theory, it will let people know that the [Canada Revenue Agency] is doing what it can to try to find ways to enforce the rules.”
Third, new consultation initiatives were launched to assess whether banks can assume more lending risks which would alleviate obligations for the government to pay for insured mortgages in case of a housing crash. Currently, the government assumes 100 percent of the costs associated with defaulted mortgages; nevertheless, exact details on how the government plans on sharing the risks remain unknown.
These measures are intended to improve fairness, introduce risk-sharing between lenders and the government, and decrease skyrocketing prices for homes in Canada’s largest metropolitans – Toronto and Vancouver. In August 2016, the British Columbia government introduced legislation that would add a 15 per cent property tax for foreign nationals buying property to reduce the runaway inflation of housing in Metro Vancouver. The Real Estate Board of Greater Vancouver reported that housing purchases declined by 26 percent in August compared to the same time last year. Many economists believe Ontario will have no choice but to do the same in the Greater Toronto Area. There is also evidence that this change in legislation in BC has resulted in foreign money being shifted to Toronto and in Seattle which places pressures on the Ontario government to react to the housing crisis. The federal government’s plan to introduce this new housing legislation that targets foreign ownership is in line with the BC government’s action plan; however, pundits believe there are some unintended consequences.
These pundits believe that the system can still be jeopardized by students temporarily living in Canada who may purchase a home with money given to them and claim this as their principal residence as they sell and share the gains with family outside Canada. There is evidence over a number of years of cases where students have purchased luxury homes and sold them for incremental profits.
Richard Kurland, a Vancouver area lawyer recently stated, “An uncle could still give the student $5-million and when the student sells for $6-million they can still give the uncle $1-million for their kindness.” Mr. Kurland believes that there are still loopholes in the legislation and the key to addressing these concerns are whether the CRA will have sufficient power and resources to crack down on foreign ownership using similar enforcement tactics the Internal Review Service utilizes in the United States.
Another significant consequence will be felt by potential first-time homebuyers who are currently renting and are saving to buy a new home. The new rule makes it difficult to be approved for insured mortgages since buyers must go through a stress test that verifies a borrower’s ability to continue to make mortgage payments at a higher interest rate set by the Bank of Canada. Mark Norman, a mortgage broker, expects that this new legislation will keep people out of the market which in turn will result in keeping them in rental positions for longer periods. This may negatively impact the economy as first time homebuyers are a significant source of new money and have a snowball effect in other industries in Canada especially in those epicenters such as Toronto and Vancouver. Since real estate is considered to be an important growth factor in the Canadian economy, the new housing rule may slow down demand for home-builders, construction workers, renovators, furniture stores, electricians, plumbers, land speculators, high-rise condo developers, and other housing-related activities that keep the economy growing.
The purpose of the legislation is clear. Both the provincial and federal governments want to stop runaway housing inflation created by foreign investors. There is a need to mitigate the unintended consequences, and while it is a step in the right direction, requires more work to be fully operational. Whether it will work out as the government plans? That remains to be seen.
Disclaimer: Any views or opinions expressed in articles are solely those of the authors and do not necessarily represent the views of the NATO Association of Canada.