A rocky stock market adds to homebuyers' woes

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As a chill settles over the real estate market in much of Canada, industry players are keenly watching for signals that buyer sentiment will heat up again in 2019.

Perhaps those market watchers should be more closely tracking the performance of stocks and bonds.

John Andrew, a professor at Queen’s University and director of the Queen’s Real Estate Roundtable, thinks much of the turbulence in housing in 2018 was a result of a wild ride in financial markets.

Rising interest rates and tighter rules surrounding mortgage lending also played a large part, he says, but those two factors don’t explain all of the shifting moods of the past year.

Rising asset prices help to buoy the confidence of consumers, he points out. That “wealth effect” influences aspiring first-time homeowners and move-up buyers alike.

“If they don’t feel wealthy, they’re not feeling secure enough to make that move.”

The most recent data from the Canadian Real Estate Association shows that annual national sales fell 11.1 per cent in 2018 from 2017. The heavyweight markets of British Columbia and the Greater Toronto Area both suffered the doldrums.

“Certainly things are slowing down – no question," the professor says.

He is now watching to see when the downturn in sales will drag down prices.

Ottawa and Montreal are two cities bucking the trend, but sales in most of the rest of Canada are languishing.

“There aren’t a lot of people sitting on the sidelines,” he says. “It’s pretty quiet out there.”

Prof. Andrew believes the stricter mortgage rules introduced on Jan. 1, 2018 continue to weigh on the market. The “stress test” that forces borrowers to prove they can afford an increase in interest rates continues to cut into the buying power of the average consumer, he says.

In Toronto, sales rallied last summer and into the fall, only to fall off again in the final two months of the year.

Prof. Andrew says rising interest rates combined with a modest price correction in Toronto convinced some buyers to move off the sidelines.

“They pounced,” he says. “There was a real perception that the party was over in terms of three per cent interest rates.”

At the same time, people invested in the stock market as they saved a down payment were doing well, he says.

But in the second half of the year, the rough ride in North American stock markets rattled house hunters. By the end of 2018, the benchmark S&P/TSX composite index had lost 11.6 per cent for the year.

Prof. Andrew points out that first-time buyers who are saving up for a property often invest their money in a conservative mutual fund or another vehicle while they save. Some of those people have seen their savings shrink by more than 10 per cent.

But even more established homeowners are hindered, he says, because the costs of moving up are so high. He estimates that move-up buyers spend at least $40,000 to $50,000 on fees, commissions and taxes – in addition to the amount they pay for a more expensive property.

Prof. Andrew says people are less likely to make the trade to a more expensive property if the pool of money they’ve been saving to cover transaction costs has suddenly shrunk.

“That’s going to be a significant impact on their ability to do the transaction in 2019.”

The very slight decline in mortgage rates announced by some lenders this month does not offset the expectation among many consumers have that the Bank of Canada will continue to tighten, he says.

“That perception that interest rates are going to rise puts a chilling effect on real estate transactions.”

Bank of Montreal chief economist Douglas Porter notes that financial markets have managed to repair some of the late-2018 damage so far in January.

Equities, bonds and oil have all staged recoveries from their lows, he says, adding that the reset is largely appropriate given the milder outlook for global economic growth.

Mr. Porter also brings attention to three weights of massive uncertainty: the U.S. government shutdown, Brexit and the trade battle between the United States and Canada.

Mr. Porter notes that sour Canadian home sales numbers, together with diminished household borrowing, are bringing out the real estate bears. But Mr. Porter counters that policy makers can point to the steam released from a piping hot market and claim “mission accomplished.”

He expects sales and prices to stabilize this year. Mr. Porter also expects population growth and lower mortgage rates to support housing in this country.

Prof. Andrew says purchases by foreign buyers have also diminished, but they were never the driving force in the market’s run-up in Toronto, in his opinion. A 15 per cent non-resident speculation tax introduced by the provincial government in April, 2017 did more to unsettle local buyers than overseas investors, he says.

As for the GTA condo market, Prof. Andrew says the condo market in Toronto has been defying all expectations of a correction.

“I’ve been wrong about condos for years – especially in downtown Toronto,” he says.

The professor says small condos of 600 square feet or so have become the 2019 version of affordable housing.

“There’s always going to be demand for that.”

While a rush of new inventory is set to arrive on the market this year and next as projects are completed, Prof. Andrew points out that most units are pre-sold.

“Some of them have been flipped two or three times.”

The bigger risk he sees is that a lot of those units have been purchased as investments. If an investor holds a five-year mortgage and interest rates rise during that period, expenses may suddenly spike at renewal time.

“What happens if you have 10,000 unit holders who all decide at once that the math doesn’t make sense?”

Owners who live in the unit will cut down on lattes, forgo vacations and take any steps necessary to avoid selling, he says. But investors have an entirely different mindset.

“If it’s an investment property, they’ll dump it.”

Prof. Andrew says prices in Vancouver and Toronto have soared so far out of line with income levels that low mortgage rates are the only thing holding up those values.

Over the long term, that creates a risk hanging over the market, he says.

“There’s no question about it.”

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