Canadian real estate might be slow right now, but a large bank thinks it’s going to “rip” soon. A new analysis from Scotiabank warns investors that the Federal government is at odds with the Bank of Canada (BoC) goals. The country’s central bank is trying to slow demand and the resulting inflation, while the Fed is doing everything it can to create excess demand. Consequently, it would be hard to create a better plan to raise home prices. Let’s unpack what the heck Scotiabank is talking about.
Pressure Makes Diamonds, But It Needs Dead Things First
The BoC has been trying to lower demand, while the Fed has been trying to stimulate it, argues the bank. Canada’s labor shortage is one of the worst seen in decades. The bank sees this as predictable, since the Fed expanded by 420,000 employees since 2020. It’s roughly equivalent to the population of Halifax, and 51% of job creation. It’s an odd choice for the Fed to stimulate its own hiring program during a tight labor market.
Scotiabank argues the same logic is being applied to housing. The Fed is stating it wants to bring down home prices, but actively working to drive them higher.
“In a broader public policy sense, Ottawa’s housing strategy remains confusing,” writes Derek Holt, VP and head of Capital Markets for Scotiabank.
“The BoC is trying to contain inflationary pressures and soften previously raging house prices. The Feds have thrown open the immigration doors into a market with no supply while another tax subsidy to housing starts up on Saturday in the form of the 1st time homebuyers tax-free home savings account that allows one to shelter up to $40k tax free with annual contributions of $8k. Housing is going to rip after a temporary retrenchment and there goes the BoC’s efforts.”
If you’re not fluent in bankster, that might need some unpacking to fully understand what’s happening.
Canada’s Immigration Policy Is As Generous As The British West Indies Were To India
Canada’s immigration policy was one of the most successful and mutually beneficial relationships. Historically, immigrants have been very successful in Canada. Unfortunately, that’s not the situation they’re entering today. High skilled immigrants are finding themselves underemployed and living in inadequate shelter. There’s constant focus on how Canada needs the immigration boost, but the country doesn’t even have a plan for basic shelter. It’s clear this is about driving demand, not a mutually beneficial growth opportunity.
Scotiabank isn’t alone on this one. RBC, Canada’s largest bank, recently echoed this opinion. They explained that immigration is the fastest solution to Canada’s demographic problem. But it takes time, you can’t just ramp up the numbers without a plan and count on churn. The bank warned that ramping up numbers without a plan for employment and shelter will just cause further inflation and higher shelter costs.
If you’re still under the impression this is 1980, and immigrants are benefitting from this—you’re mistaken. Canada’s recent immigrants report feeling misled, with 2 in 5 preparing to return home. The country is run like a shady factory exploiting workers through a dodgy temp agency. It doesn’t matter if it’s possible to meet your basic needs, they just need someone to fill the seat.
A shady factory sure can produce profits though. In this case, higher rents are a big win. That can translate to higher home prices when interest rates fall.
Canada’s New Tax Subsidy To Raise Home Prices Starts This Weekend
The tax subsidy mentioned by Holt is also another artificial demand-side pressure. In case you need a refresher, the First-Time Homebuyers Tax-Free Home Savings starts tomorrow. It’s a registered account like your RRSP, RESP, or TFSA that allows tax benefits for putting away more money for housing.
Critics argued it was a problematic solution from the start. It doesn’t replace the existing Home Buyers Plan (HBP), which allows first-time buyers to borrow up to $35,000 from their RRSP. It exists in addition, further incentivizing housing investment.
If you’re from Canada, how many people have told you their home is their best investment? It probably was. They likely made minimal investments otherwise, because all of the incentives are being slanted to housing. This has led Canadians to invest less in productivity, and more into non-productive asset trading. It’s actually getting so bad that Canada now holds the spot Greece previously did during the Great Recession in the OECD forecast.
The siphoning of tax-based incentives played a major role when inflating US home prices in the early 2000s. It also played a significant role inflating Canadian home prices post 2019-election. In a market, the role of the person that holds the asset is to capture as much capital as possible. If the Federal government is incentivizing you to put more capital into a home, a seller’s role is to capture that additional income. That’s how markets work—especially when you’re discussing shelter, which Canada views as a bond you live in.
Mo (Shelter) Money, Mo (Shelter) Problems
In addition, there’s the introduction of more leverage into the real estate market. The price of an asset is not determined by how many people want it, but what someone is willing to pay. Since shelter is mortgage dependent in Canada, the role of financing plays a major role in the price of a home. To understand this, first you need to understand how very mistaken economists were about interest rates.
It’s widely believed that lower interest rates reduce the cost of housing. The legend repeated amongst central bankers is that cheaper rates mean more goes to principal. Home prices are strictly influenced by the demand for the supply available. Even the BoC has determined that was spectacularly wrong.
Looking at 30 years of data, a BoC head found people adjusted their spending to credit. As interest rates fell, people just kept spending the same share of income on the asset. Buyers continued to adjust their spending, inflating home prices without spending more. After 30 years, the BoC finally decided to study what they were doing, and it turned out to be wrong. Whoops!
Sidenote: If you’re thinking, “but low rates help people buy their first home,” that’s not true. Prestigious NBER researchers from MIT Sloan and Boston University, determined that credit supply shocks increase home prices, but the change in ownership is insignificant. Sad trombone.
This behavioral principle is likely to apply to the tax incentive, in addition to the diverted funds. If people typically put down 10%, they’re likely to continue putting down 10%. Additional funds aren’t likely to make it easier to put it down, but they’re more likely to be incorporated as a part of the norm. The final price would just adjust to reflect the influx of new capital for the segment first-time buyer’s purchase. Ultimately, the only real limit is the amount that can be spent on servicing a mortgage.
Holt’s right, the Federal government is very confusing when it comes to housing policy. If you wanted a perfect plan to increase home prices, you would create new demand, incentivize it, and then increase its leverage. Examples would be something like increasing immigration, giving tax breaks for one specific segment of investing, and increasing leverage for just that segment.
Why does that sound familiar?
Anyway, home prices can’t rise forever since eventually it creates systemic issues that result in more permanent economic damage. However, home prices can climb until it hits that point with reckless policy.