Cooling Speculation in Toronto Real Estate
Author: Tracy Ruddell
Part two of our series on Speculation in Toronto Real Estate
The release of Budget 2017 with its focus on housing affordability has fueled even more debate among politicians, economists and Real Estate professionals on how to cool the Toronto Real Estate market. Although no one can agree on exactly what to do and who’s responsible, there’s one thing that most parties agree on: the skyrocketing prices of Toronto homes for sale needs to be addressed. Fast.
Yesterday, we talked about the difference between speculators and investors and how speculation in particular is a concern in today’s Vancouver and Toronto Real Estate markets. Today, we’re taking a look at some of the options that the Federal, Provincial and Municipal Governments have to cool speculative activity and the pros and cons of each.
The key to any successful market control measure is to:
1. ensure it’s quickly implementable, easily enforceable, targeted to the right market segments and will have a large enough impact to be worthwhile, while
2. not being so over-ambitious as to swing the pendulum too far the other way, less all of the “bubble is going to burst” fear-mongering becomes a self-fulfilling prophecy.
The latter point is a serious concern. That’s one reason why it’s taking politicians so long to take action. A market crash–while it may sound attractive to renters who can’t afford to break into the current Real Estate market–will negatively impact all of us, not just speculators, investors and developers.
For current homeowners, imagine owing more on your home than you’ll make back in re-sale. Not so hard to imagine if we take a look back at what happened around 1989, 1990 when average home prices dropped signifcantly; the lowest point of that crash period saw Toronto housing prices sink more than 25% from when the market started its downturn. Now, the market had arguably started its recovery by 1994 although it wasn't unitl the early 2000s that we started to see this continual, annual rise in prices we've now become accustomed to.
It took the average home over a decade to recoup it's lost value from the early 90s crash. Even so, many homeowners simply rode out this period of sky-high interest rates and focused on the long-game. For young buyers, though, especially those with high-ratio mortgages and as little as 5% down, a crash could be devastating. They may not be able to afford interest rates like we saw in the early 90s (remember 14% mortgages?) or worse, the mid 80s when speculation was getting out of control (21% mortgage rates!), potentially forcing many Canadian home owners to sell at a loss.
So, what can the Government and the industry do to slowly restrict levels of speculation in the market without shocking the system? There are a number of options.
Rather than a foreign buyer's tax, is it time for a speculation tax that would likely cover a larger investor market? It wouldn’t be the first time. Ontario introduced a speculation tax back in 1974 but it was revoked by 1978. It would certainly be a quick solution but the problem is, it may not solely hit the buyers it’s intended to stop.
Garry Marr of the Financial Post reported on this issue last year. According to Real Estate Broker Barry Lebow who was active in the development world at the time (owning 53 houses and suddenly owing $1.5M in unplanned taxes in 1974 when the new tax hit), the market comparisons between now and then are not so easy to make.
“It really was a case of four or five players, a few major developers. It was quite different than what is going on today,” Lebow told Marr.
Speculation tax gets a little muddier in today’s world with so many “joe publics” dabbling in the market. How do you separate speculators from traditional investors and decide which tax applies? Do you base it strictly on time, i.e. any property sold in less than a year can be considered a speculative transaction? When you have “professional” speculators who own dozens of pre-construction properties along with empty units, then it’s pretty clear. But what about the person who purchased one pre-con property and failed to move in, selling on assignment or re-sale? Are they a speculator? Just as with capital gains, it comes down to intent at time of purchase and that’s not always easy to prove.
Although not a part of Budget 2017, a change to capital gains tax structure is not off the table. Should capital gains on flipped properties be charged at a higher level than 50%, as suggested by Ontario’s Finance Minister, Charles Sousa? There is precedent. In 1988, we saw an increase to 66% and in 1990 to 75%; the latter lasted a decade.
As with speculation tax, however, we really feel that intent at time of purchase should be considered which is why we would suggest that a rolling scale, based on number of properties sold, may make more sense than a blanket increase. We can’t tell you how many people we’ve worked with over the years who bought a pre-construction condo or townhome (without the advice of a REALTOR®, unfortunately) and then their life changed in the three or four years that they were waiting for it to be built. They may have gotten married, had to move for work or lost their job and could no longer afford the property. Many people end up selling on assignment before close who aren’t speculators.
The reality is, a lot of these people (sadly) end up selling at a loss and so capital gains wouldn’t apply anyway. If they are lucky enough to make a profit, however, should they be taxed in the same manner as wealthy, foreign investors buying out whole floors of condos? Maybe, but taking that kind of blanket-approach seems to work against the very thing we’re trying to achieve through market controls–helping the average Canadian get a leg up in the housing market while not over-leveraging themselves.
As the law currently stands, there are still plenty of people escaping capital gains already and so there’s money being left on the table from a Federal standpoint. The problem with policing capital gains is that there are qualitative factors to consider; it takes resources to track down, audit and potentially prosecute offenders.
If you recall in Budget 2016, it was strongly suggested that the CRA would be doing just that–putting additional resources towards hunting down capital gains tax-dodgers. Certainly, the requirement to now report the sale of your Principal Residence on your tax return seems to be a step in that direction, i.e. aiding the CRA in finding those who are wrongfully hiding behind the Principal Residence Exemption (not the average home seller).
The higher the capital gains tax, however, the more tax-dodging activity is going to occur, the more money and time needed to track down offenders. Doesn’t mean it shouldn’t happen but it’s a solution that requires additional resourcing.
Even without accurate data on foreign buyers as a percentage of overall GTA home ownership, there’s little doubt that when it comes to speculative buying, wealthy foreigners are part of the Toronto home buyer mix.
We can tell you that, from our experience, concentration has largely been in two specific property categories: the pre-construction Toronto condo market and the high-end, luxury home market. This has likely been the case for more than a decade now. That’s worrying enough, when you have foreign buyers purchasing whole floors of condo buildings, but our current stock shortages are causing the issue to spill over to the general market.
A foreign buyer tax would certainly start to cool activity. Whether or not it will cool the market enough to have a positive impact on the everyday, local, would-be home buyer is another question. Likely not, to be frank, however it is an important step of many and it needs to be taken immediately, in our opinion. I must say, ours is an opinion not shared by many of our fellow REALTORS® nor the Toronto Real Estate Board.
Our CEO Carl Langschmidt recently gave his point of view on this issue with our partners over at Condos.ca. You can read their post here. If you’re interested in the Toronto condo market specifically, we encourage you to read their weekly blog which is an excellent source of information for the latest news and policy changes impacting condo buyers and sellers.
The challenge with solely relying on foreign buyer tax is that foreign buyers are just one part of a larger problem here in Toronto; there are a heck of a lot of local speculators, also. And the really wealthy foreign buyers who are seeking an offshore safe haven to park their wealth over the long-term may not be phased by this tax. Worse, it could roll the problem over to other Canadian cities like Calgary where local REALTORS® believe they're already seeing an uptick in foreign interest.
We don’t hear this one kicked around often but it’s worth consideration: increased Land Transfer Tax (LTT) for any property purchased over and above your Principal Residence. With LTT, there are no qualitative factors to consider. The intent of the buyer at time of purchase becomes irrelevant. We do think this should be on a rolling-scale, however, increasing with each additional property purchased. The intent is not to further ding people who buy one additional property such as a cottage, for example. In that vein, an increased tax may be better applied to the Municipal portion only.
With a focus on LTT, the City of Toronto (and/or the Province) would manage this directly with no CRA resources spent investigating on a case-by-case basis and no worry of honest, end-user buyers getting slammed with huge taxes that shouldn’t apply. The idea of these market corrections is to slowly cool the market and protect the average Torontonian, after all, not make them lose their shirts.
We like this idea for its simplicity. Senior economists at Scotiabank agree. Earlier this month, they released a statement in favour of a "flipper's tax" in the form of higher LTT on properties beyond a Principal Residence. Jean-François Perrault, Chief Economist for Scotiabank, believes that a foreign buyer's tax isn't the solution and in fact, that the impact people think it had on the Vancouver market is overblown. As quoted by the CBC:
"Prices started to decline well before the foreign buyers tax," said Perrault. "The data we've seen over the last couple of months in Vancouver suggest that house prices have begun to reaccelerate." He goes on to say that "If you're looking for kind of a permanent solution to the housing market in Toronto... you need something that has a little more of an impact on a broader market."
This is where LTT makes more sense. Of course, there will always be people who will put second and third properties in other’s name in order to evade taxes and so this also is no perfect solution. The LTT increase would also have to be significant enough to be a deterrent for speculators. Considering the 30% annual price gains we’re seeing on average right now, high-level speculators would likely just see it as a cost of doing business; something they could earn back within a few months of market appreciation.
Now, increased LTT at time of purchase on second+ properties AND increased capital gains at time of re-sale, when sold in less than, say, two years? That's a deterrant. Would it be too much, too soon, though?
Are banks at the heart of the issue? Some argue that taxes of any kind are a knee-jerk reaction and avoid the real issue: poor decision-making by the Bank of Canada and loose lending policies by banks. Not only have low-interest rates fuelled demand to unprecedented levels, relaxed lending policies in some cases are making speculation more attractive.
Higher interest rates are certainly one option for addressing that, quickly, however the average GTA family is leverage so high that any change in rate could leave thousands unable to carry their homes. Likewise, even tougher qualification criteria across the board than we have now, while an easy option, would hurt the very people we’re trying to help. The way things are with Canada’s new mortgage rules, the already-tougher financial stress tests are hitting first-time buyers the hardest.
We also can’t ignore the role that the Canadian Mortgage and Housing Corporation (CMHC), a crown corporation, has to play here. In January, the CMHC released a statement to the press. Bob Dugan, the agency’s Chief Economist, warned:
“Price acceleration in Vancouver, Victoria, Toronto and Hamilton indicates that home price growth may be driven by speculation as it is outpacing what economic fundamentals like migration, employment and income can support... Home buyers should ensure that their purchases are aligned with their needs as well as the long-term market outlook."
But isn’t the CMHC’s approach part of the problem? They guarantee about half of the mortgages in the market. An increase in premiums or tougher qualification criteria would instantly deflate the market. Again, though, would a move like that be targeting the right buyer segments? How should lenders zero in on the speculation market, specifically?
The Bank of Canada has been warning of a possible bust, that the current Toronto and Vancouver housing markets are unsustainable (singing a very different tune now than they were last year) but haven’t they helped create this issue? Soheil Karkhanechi reporting for CBC News certainly thinks so with his piece last week on inexpensive credit for speculators fuelling irrational housing price increases. He writes:
“…despite all the noise about a possible solution, few seem interested in what is always and everywhere the underlying cause of economic bubbles: speculative behaviour fed by inexpensive credit.
No, I am not asking that the Bank of Canada raise rates prematurely to address the housing issue. In the Canadian housing finance ecosystem, there is actually a much better, targeted too for dealing with speculative behaviour: cracking down on nonconforming mortgages.”
What Karkhanechi’s referring to are non-traditional mortgages or other types of loans that buyers seek when they don’t qualify for a traditional mortgage. This isn’t just from private lenders. Big banks will sometimes give loans based off of equity / collateral versus income. The problem with this is that it doesn’t focus on the borrower’s ability to pay off their debt each month and this is where a lot of speculators get into trouble.
The truth is, a lot of local speculation would dry up naturally if the banks just stopped lending speculators money. There certainly is a segment of foreign buyers playing in this arena also (as they have no Canadian income and so only qualify for non-conforming mortgages). However, the trouble with focusing solely on mortgage lending policy is that a lot of speculators, particularly wealthy, foreign buyers, are doing all-cash transactions. Tightening lending policies on non-conforming mortgages and/or increasing interest rates on those products may only hit a certain segment of speculators.
We'd be remiss if we talked solely about tempering demand and didn't address the issue of supply.
People love to point fingers at builders but we can’t forget that these are private developers, in the business of making money. Their mission is not to address housing affordability or the lack of family housing. Their focus is to build whatever type of property will fetch them top dollar and sell to the highest bidder. We'd love to see restrictions placed on condo developers that stop them from selling an unreasonable number of units to one buyer or company but that's unlikely to happen.
What can help shape their activity however is a shift in how the City awards permits along with the creation of new incentives aligned to City building goals, e.g. more rent-controlled apartments and single-family homes where there are pockets of under-utilized land. With the right incentives at the right scale, it’s no longer speculators who will be driving the new build market.
What exactly should those incentives be? That’s a discussion for another day but we’d love to see Toronto lighten up on zoning restrictions and encourage more innovative use of laneways, for a start. An increase in building activity doesn’t have to mean loosening the Green Belt restrictions, as many fear. That’s a positive Real Estate story coming out of Vancouver that we can learn a thing or two from.
We want to hear from you. How do you think we should cool speculation without crashing the entire market? And what role should each level of Government play?
Image Credits: Hot property by Rob Hyrons and capital gains tax by KongNoi both from Shutterstock. Photo of CMHC's Ottawa headquarters by Robkelk from wikimedia. Image of downtown Toronto © Property.ca.