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Home prices under ‘full-scale attack’ as interest rates, taxes rise: economist

Click to play video: 'Ontario hikes tax on foreign buyers to 20% as it expands province-wide'
Ontario hikes tax on foreign buyers to 20% as it expands province-wide
Ontario Finance Minister Peter Bethanfalvy said Wednesday that the government was increasing the foreign homebuyer tax from 15 to 20 per cent, and expanding it to the entire province – Mar 30, 2022

The Bank of Canada’s path to rising interest rates coupled with new provincial taxes on non-resident buyers could send home prices down more than 10 per cent, according to an analyst with the Bank of Montreal.

BMO senior economist Robert Kavcic wrote in a note to clients Wednesday morning that “there is now a full-scale attack on Canadian home prices across various levels of policy.”

He cited marked expectations of surging interest rates in the months ahead and new or higher taxes on real estate speculators and non-resident buyers in some provinces as the biggest factors that could see home prices take a hit in the year ahead.

Reuters reported this week that money markets are betting the Bank of Canada could raise its overnight rate target by up to 225 basis points before the end of 2022. Such a hike could see the key rate rapidly rise from its current 0.5 per cent level to 2.75 per cent over the next nine months.

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To do so, the central bank might take the rare step of raising interest rates by half a percentage point at its next meeting on April 13. BMO is expecting 50-basis-point hikes in the next two Bank of Canada announcements, followed by a return to 25-basis-point hikes in July.

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The Bank of Canada first hiked interest rates by a quarter percentage point earlier this year, a move that some observers say has already had a “cooling effect” on the country’s hot housing market.

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In an interview with Global News on Wednesday, Kavcic said it’s arguable that the Bank of Canada is “well behind the curve” on raising interest rates as inflation surges and home prices continue to set records.

“Because of that, they’re going to move quickly,” he says. “That’s the single biggest measure we can take here to cool down the pace of home price growth and inflation more broadly.”

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Prices could drop as new taxes take hold

The Bank of Canada is not the only actor targeting the housing market, however.

Ontario announced this week that it would raise its existing tax on non-resident buyers to 20 per cent and expand the policy provincewide. Nova Scotia also said it would implement a purchase tax on non-resident buyers.

The involvement of investors and real estate speculators has been one of the factors driving up Canadian home prices, Kavcic argues.

“We’ve seen, over the last year, some speculation and investor activity push up prices beyond what would be justified by income and employment and demographic fundamentals and all that kind of stuff that usually drives house prices,” he says.

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If history is any indication, Kavcic says the coincident moves from the Bank of Canada and Ontario policymakers could send house prices down.

The situation resembles 2017, he explains, when Ontario first introduced its non-resident buyer tax. At that same time, the Bank of Canada was also in a cycle of raising interest rates in an effort to clamp down on rampant price growth.

The result then was a 10 to 15 per cent decline in detached home prices in the Greater Toronto Area, Kavcic says.

“It’s kind of an echo of what we saw in the last cycle, where we had a very strong run in home prices,” he says.

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“If we saw 10 per cent after early 2017, when arguably we weren’t as frothy as we are today, we could see more than that.”

A drop in prices and some lost equity for homeowners might not be a problem for the Bank of Canada, Kavcic says.

Because the average home price in Canada has surged over the course of the pandemic — up 26.6 per cent year-over-year in 2021, according to the Canadian Real Estate Association — giving back even 15 per cent of the value of those homes won’t set most households back, he argues.

“They’re an inflation-targeting central bank and their first job is to get inflation back down into that one-to-three per cent range. And if lower house prices are a byproduct of that, they’re going to have to just let it go.”

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