Let the pandemic smoke clear, then see where the housing frenzy stands

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As Canada’s housing frenzy reaches a fever pitch, there’s no lack of finger-pointing about who to blame for skyrocketing prices. There’s a desire to do something to correct some perceived misbehaviour, before the miscreants make further habit of it.

I’ve got a different suggestion. Let’s just wait. There’s still a pandemic going on, if you hadn’t noticed.

It’s easy – and, frankly, a bit lazy – to lay the blame at the Bank of Canada’s doorstep. The bank’s decision to cut its key rate to near zero, its promise to keep it there until the economy returns to full capacity, and its purchases of government bonds in order to dampen market interest rates certainly have made mortgages a bargain.

But raising interest rates to slow the housing market is a non-starter. The central bank’s objective with it rate cuts and bond purchases is to return the broad economy to full speed and defend its 2-per-cent inflation target. This is not the first time the housing market has been caught in the wake. But the bank hasn’t been willing to raise rates specifically to quell housing booms in the past; it’s certainly not going to now, when the pandemic continues and the broader economy still faces innumerable other challenges.

Regardless, there is a lot more to this situation than cheap mortgages. The pandemic has created a lot of distortions in the marketplace that have nothing to do with the low interest rates delivered by the central bank. Those are feeding housing demand in ways that no simple rate cut could – and that a couple of rate hikes tomorrow wouldn’t reverse.

The nature of the pandemic – stay-at-home orders, remote work and school, concerns about physical distancing – has made modest-sized apartments in downtown condo towers much less desirable than they looked before the crisis. There has been a sudden surge in demand for larger homes in the suburbs and smaller cities – places where the supplies, in many cases, were not available to meet the unexpected shift in consumer preference.

Meanwhile, shutdowns have severely restricted consumers’ options to spend, notably on some big-ticket expenses such as vacations. At the same time, federal government supports have more than replaced lost incomes across the economy. The result has been a massive increase in total household savings; for many prospective home buyers, that has accelerated their capacity to make down payments, and to go after larger and more expensive homes.

The beneficiaries of this surge in housing prices are sellers and existing owners; it seems many observers view them as profiteers of the COVID-19 wars, their personal wealth soaring as the value of their home rises. There’s a growing movement to claw back those gains by removing, at least partially, the exemption of the sale of a primary residence from capital gains tax.

While there’s certainly a tax-the-rich element to this idea, Royal Bank of Canada senior economist Robert Hogue argues that the capital gains exemption has long promoted housing demand; it amounts to government promotion of purchasing houses over other kinds of assets. Still, with roughly two-thirds of Canadian families owning a home, such a move would not be politically popular.

Most suggestions for cooling the housing frenzy – higher interest rates, tighter mortgage requirements, taxing capital gains on residences, higher land transfer taxes – boil down to ways to dampen demand. But if a 17-per-cent rise in the average price of a house in the past year hasn’t slowed prospective buyers, why are we so convinced that a nudging-up of taxes, or an increase in borrowing costs from ridiculously low to merely very, very low, will do the trick?

Maybe one prudent path would be to simply wait for these pandemic-related distortions to eventually pass. The dramatic pivot to suburban and small-city single-family homes may well fade as lockdown restrictions lift and life returns to normal. The conditions that created the savings-glut payments possibly will dissipate. And, yes, interest rates will eventually rise.

Once those factors fade, there are strong arguments that the demand side of the equation is not, fundamentally, the problem for Canada’s housing market. The residential real estate industry has long argued that housing supply is the bigger issue, and the more promising solution to improve affordability.

“Policy makers should redouble efforts to address supply issues that existed before the pandemic,” the Royal Bank’s Mr. Hogue wrote in a research note last week. He recommended easing a range of regulatory burdens that slow or outright discourage construction of residential properties.

Mr. Hogue cautioned Ottawa to resist the temptation to introduce measures to come to the aid of first-time home buyers, who increasingly feel priced out of the market.

“Without corresponding measures to boost supply, any measures that ultimately heat up demand further – while probably helpful to the first people who take advantage of them – increase the odds of perpetuating problematic price trends and household debt issues,” he said.

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