Monetary and tax policy present risks to housing market

Despite soaring prices, Canada’s housing market is more stable than it looks, a new report says, though monetary and tax policy could upset the balance.

The national average home price climbed by more than 20% year over year in February to a record $816,720, leaving many to worry about affordability and whether rising interest rates could spur a correction.

A report released Tuesday from CIBC, the Conference Board of Canada and Re/Max noted the anxiety caused by the last two years’ housing market frenzy, but said the market could settle with the appropriate mix of monetary and tax policy.

The report looked at various scenarios for housing over the next five years. In the first, the Bank of Canada raises interest rates at “a reasonable schedule” of four times per year to keep up with growth and contribute to a “less heated” market. Housing would remain expensive but price growth would flatten somewhat, the report said, and gradual rate increases wouldn’t affect mortgage payments.

“Canada’s housing market is far more stable than many people and industry watchers perceive,” said CIBC deputy chief economist Benjamin Tal in the report.

“Yes, there are specific caveats, such as prolonged inflationary pressure, that could upset the balance, but should the BoC stay pragmatic and consistent, the next five years look entirely sustainable for Canadians.”

A separate report from CIBC released Monday predicted rate increases in Canada would stop in the 2.25% to 2.5% range.

However, the housing report noted the risk of over-tightening. With inflation at the highest level in three decades, Tal said a more aggressive Bank of Canada that raises rates eight times per year could lead to a recession. In that scenario, housing demand would fall and existing homeowners would have a harder time paying mortgages, he said.

Finally, the report examined what could happen if the federal government removed the principal residence exemption. The Liberal government has not said it’s considering such a policy. The report suggested the policy could be introduced as a response to pandemic deficits and the hot housing market.

Jamie Golombek, managing director of tax and estate planning with CIBC Private Wealth, said in the report that a capital gains tax on the sale of a primary residence could be applied on a prorated basis, determined by the home’s value or or how long it was owned. Such a move could incentivize sellers and, in the short term, increase inventory.

However, it could also have broader economic consequences.

“The primary homes of Canadians represent the greatest store of value for most homeowners and removing a significant portion of that value by eliminating the exemption could cool the market in profound ways,” Golombek said.

“While it theoretically will improve government coffers, it would be a blunt blow to the net worth of Canadian households, which in turn could dramatically swing the housing market from hot to cold.”

A CIBC report last fall found that parents gave their kids more than $10 billion for down payments over the previous year.

Removing net worth from older Canadians with a change to the principal residence exemption could disrupt the transfer of wealth and erode affordability, Tuesday’s report said.

Staff

The staff of Advisor.ca have been covering news for financial advisors since 1998.