Three ways Ottawa could cool the housing market in the federal budget

As Canada’s home prices reach the stratosphere, calls on the government to bring the housing market back to Earth — possibly with a soft landing — are growing increasingly urgent.

Some of Canada’s big banks have recently joined the chorus.

“Overheated markets threaten to destabilize the economy down the road if or when a correction occurs, with possible heavy costs for governments,” Robert Hogue at RBC Economics has warned in a note to clients.

Policymakers should act “immediately” to address soaring property valuations before “the market is left exposed to more severe consequences,” BMO senior economist Robert Kavcic echoed in a similar report.

The average price of a home in Canada has climbed an eye-watering 25 per cent to a record $678,091. And the housing frenzy shows no sign of cooling off. The Canadian Real Estate Association (CREA) expects the national average home price to keep climbing fast in 2021.

While previous housing market booms have been centred around big cities, and especially Vancouver and Toronto, the current housing fever has swept the whole country, with the steepest increases registered in smaller communities and lower-cost provinces.

In Ontario’s cottage country, for example, prices in Tillsonburg District and Woodstock-Ingersoll are up more than 35 per cent compared to February of last year. Prices are up 28 per cent in Greater Moncton and 16 per cent in Chilliwack, B.C.

And while the pandemic housing spree was initially driven by Canadians yearning for bigger spaces and backyards, analysts are growing increasingly concerned about speculation and purchase decisions based on buyers’ fear of missing out.

“The action needed today is one that immediately breaks market psychology and the belief that prices will only rise further,” Kavcic wrote.

There’s little doubt that ultra-low interest rates are fuelling the fire behind skyrocketing home prices. But adjusting Canada’s trend-setting interest rate is the purview of the Bank of Canada, not the government. And with the economy still a ways away from pre-pandemic levels of activity, the central bank has made clear it isn’t going to hike rates any time soon.

As the federal government prepares to announce its first federal budget in two years on April 19, expectations run high the Trudeau government will announce new measures to pull the reins on Canada’s runaway housing market.

For now, the Liberal government remains tight-lipped about what may or may not be in the federal budget when it comes to housing.

“We continue to closely monitor the health and stability of the housing market. We cannot however comment on what may or may not be under consideration for the upcoming 2021 budget,” Katherine Cuplinskas, press secretary at the office of Deputy Prime Minister and Minister of Finance Chrystia Freeland, said via email.

But over more than 10 years, Ottawa has already intervened several times to tame home prices with anything from higher down payment requirements to the mortgage stress test, which reduces the amount buyers can borrow from federally-regulated lenders.

What else can the federal government do?

Global News put the question to three real estate experts. Here are four of the big ideas they discussed:

The Liberal government has already floated the idea of a tax on foreign homeowners who live outside of Canada as part of a plan to lower housing prices.

It’s an idea spearheaded by provinces such as British Columbia, Ontario and Prince Edward Island, but John Pasalis, president of Realosophy Realty in Toronto, says current activity by real estate investors has been dominated by domestic players.

“Any policies that should be put in place should just be geared towards investors, period, whether domestic investors or foreign investors,” Pasalis says.

To discourage buyers from purchasing property only to flip it after a short period and pocket the gain from rapid appreciation, Ottawa could impose a tax on residential real estate sales with the rate gradually falling to zero over five years of holding the property, Kavcic says.

“This could easily crowd out speculation and alter market psychology,” he wrote in the report. At the same time, the measure would have no impact on long-term homebuyers.

Any national speculation tax should avoid focusing narrowly on very quick repeat sales, says Diana Petramala, senior economist at the Centre for Urban Research and Land Development at Ryerson University. Instances of investors who buy homes only to re-sell them six months to a year later remain relatively rare, she says. Flipping homes after holding them one to two years is more common, she adds.

The notion of taxing capital gains on a principal residence is gaining attention, but all three experts Global News spoke with were cool on the idea.

A capital gain refers to when you sell an asset for more than you bought it. Canadians currently have to pay tax on capital gains on investments such as stocks a real estate but not when it comes to their primary residence. Capital gains tax only applies to secondary residences (think: vacation homes and investment properties).

Extending the capital gains tax to primary residences would be problematic because the home is the biggest investment many Canadians have, Petramala says.

“There’s an equity impact … especially for seniors,” she says.

But the measure could backfire for millennials, as well, by discouraging older homeowners from downsizing and freeing up some of Canada’s scarce supply for larger properties, she adds.

Still, the government could shape a speculation tax as a special capital gains tax on short-term sales, says Kavcic. The tax would mean that those who buy and sell a property at a profit within a short period of time wouldn’t get to pocket as much of the gain as they do right now.

On principal residences, homeowners would have to pay a capital gains tax if they sell for a higher price within a few years. On non-principal residences, owners would have to pay capital gains at a higher rate than they currently do, Kavcic wrote in his report.

But broadly increasingly the current capital gains tax on non-primary residences without specifically targeting short-term resales could have significant undesirable spillovers, Kavcic noted in his report.

“Such a measure would … discourage all forms of real estate investment, not just flipping. For example, it would reduce the incentive to own long-duration rental property, which could work against much-needed rental supply,” he wrote.

Tightening mortgage standards is “a well trodden path” for the federal government, Kavcic wrote. But the impact of a further regulatory tightening would be “low,” he wrote.

But the current mortgage stress test, which vets borrowers’ finances based on an interest rate that’s higher than the contract rate they’d otherwise qualify for, is only mandatory for federally-regulated lenders, which include all the big banks. It would help if provincial governments adopted similar rules for provincially-regulated lenders, Petramala says.

And further raising the bar for qualifying for a mortgage would make it even harder for first-time homebuyers to get into the market, Pasalis says.

“Any policies that the government puts in place should really be making it harder for investors to capitalize on the housing market, not … make it harder for first-time buyers to get into the market,” he says.

For example, Pasalis says, Ottawa could follow the example of New Zealand, which recently reinstated lending restrictions it had removed after the onset of the pandemic, raising the minimum down payment required for home purchases by real estate investors to 30 per cent with plans to further hike that threshold to 40 per cent starting in May.

And Canadian policymakers should be careful about introducing measures that hurt first-time homebuyers because when young people can’t afford a place to live, they leave, Petramala says.

“Housing affordability is something that drives people away,” she says. “So you maintain economic competitiveness, you want to keep people here.”

Measures that curb the demand for housing are the short-term fix to rein-in an unbridled real estate market, Petramala says. But demand-side policies tend to have only a temporary effect. They can dampen the collective euphoria and push many buyers to the sidelines for a little while.

Eventually, though, people tend to adapt to the new rules, whether it’s saving longer for a bigger down payment or coming to terms with buying a smaller house, she adds.

Holding back housing demand will buy policymakers time they should use to roll out long-term solutions, Petramala says.

That means tackling chronic housing supply shortages, Petramala, Kavcic and Pasalis agree.