The Canadian Government Launches Predatory First-Time Buyer Mortgage Scheme

The Government of Canada is using taxpayer money to invest in real estate at near peak valuations. The Department of Finance revealed the 2019 Budget yesterday, including new housing measures. Most notable is the First-Time Home Buyer Incentive, which allows the CMHC, Canada’s national housing agency, to become an investor in your real estate. On the surface, it seems like it may provide a boost to the market, and is a generous gift to first-time buyers. The program’s timing however, makes it a predatory loan scheme that will do more harm than good. How you ask? Let us count the ways.

First-Time Home Buyer Incentive

The First-Time Home Buyer Incentive is a “shared equity” program, announced in the 2019 Budget. The program allows insured first-time home buyers to let the CMHC become a co-owner in their home. The Crown corp will kick in 5% on a resale, or 10% towards new housing. The program launches in the fall, and the government hopes it will “increase the supply of housing.”

Full details won’t be released until later this year, but the gist of it is laid out in the 2019 Budget. First-time home buyers with a household income of less than $120,000/year can qualify. The mortgage amount needs to be less than 4x the household income, and you pay it back upon selling. Since the program is a “shared equity” program, it appears the CMHC would assume a stakeholder risk.

Why Tho? Using Young People To Reduce Capital Overhang

Capital overhang is when an asset is about to flood the market. This is when more supply will reach than can be readily absorbed by qualified buyers. Since not all of the supply can be absorbed at the same time, the asset drops in price until there is a buyer. This drops the value of the total market, and makes it harder for existing owners to sell. For example, if an institution dumps a large position, their position overhangs the market. The result is existing asset owners won’t have liquidity, and prices fall.

During the Great Recession, the US used policy to address a capital overhang in real estate. The First-Time Homebuyer Credit was billed as a way to help young homeowners buy into the market in 2008. The unspoken purpose was to reallocate homes from distressed owners, to buyers that could afford to take a hit. Great news for distressed investors, but not so great for the buyers.

US Real Home Price Index

The inflation adjusted value of US home prices.

Source: St. Louis Fed, Better Dwelling.

Economists observed it persuaded first-time homebuyers into moving up their purchases, and “buy into bubbles.” Yes, the government threw first-time buyers under the bus. Great if you’re were a speculator, you didn’t lose everything. Not great if you were a first-time buyer, because they fell behind on wealth building at best.

Bonus Fun Fact: Usually an institution will try to “iceberg” a large equity position, before showing an overhang. This is when they execute several smaller, harmless looking orders that aren’t as obvious to buyers. The Canadian real estate industry has already been running a similar strategy. You only run an overhang trade when pending losses begin to look unavoidable, and speed is needed.

It Will Slow Resale Real Estate Markets Further

The program may sway first-time buyers to stay out of the market this year. Details of the program won’t be released until later this year, and it won’t be live until at least this fall. Prominent mortgage broker Ron Butler pointed out buyers are now incentivized to wait until the fall. Canadian real estate sales are already at Great Recession levels. The government may have just slowed it down even further, and faster. Quite the accomplishment.

Canadian Real Estate Sales

The unadjusted sales for all home types, as reported through the Canadian MLS.

Source: CREA, Better Dwelling.

Creating Developer Liquidity

Let’s not be naive, this was a taxpayer funded gift to real estate developers. Let’s ignore that they said we need to stimulate construction while it’s at an all-time high. Instead, let’s just look at the buyers balking at prices at these levels. In Toronto, only 8.7% of new home inventory was absorbed in January. Vancouver did slightly better but still terrible, with 10% of new inventory absorbed. Not even negative cap rate investors are stepping in at these valuations.

Toronto and Vancouver New Home Sales

The number of new homes for sale, compared to the number of sales in January 2019.

Source: MLA Canada, Altus Group, Better Dwelling.

Typically in situations where demand falls, and supply increases – prices come down. Analysts expect prices to fall rapidly when absorption falls below 12%. Now that we’ve reached that point, the government steps in with a bag of tax dollars. In fact, the CMHC is offering 2x the amount of investment if you buy new construction, instead of a gently used home. At least this helps developers lower their risk of failure. The death of one developer’s equity is a tragedy. The death of many millennials equity is a statistic.

Trudeaus Have A History of Making First-Time Bagholders

This isn’t the first-time Canada is rolling out first-time buyer schemes at peak. In 1982, Prime Minister Pierre Trudeau’s budget launched the New Home Construction and First-Time Buyers’ Plan. The program provided a CMHC grant of $3,000, after national prices rolled back a year. The program was popular for the first-few weeks, then stagnated as prices fell. It was discontinued one year later, and as prices fell further. Love the progressive values of the Trudeaus. Hate that they mobilize young people as corporate pawns.

First-Time Bagholders?

The inflation adjusted value of Canadian home prices, and the launch date of the “New Home Construction and First-Time Buyers’ Plan”. The first-time buying scheme was discontinued one year later.

Source: Dallas Fed, Better Dwelling.

In my opinion, there are a few other implications – especially around credit. However, these are the really big ones that immediately stand out. The scheme is either very well thought out, and they expect a massive capital overhang. That would imply they are intentionally setting up young people to absorb some of the losses. Or it’s very poorly thought out, and they did very little studying of the actual impact. Either way, at least it’s not as dumb as the mortgage industry blaming the impact of “Steves” on the real estate market.

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  • Good Lord Whatta Mess 5 years ago

    Similar strategy rolled out in BC a few years ago. Only speculators bought in. Got Millennials to absorb condo apartments quickly, so developers could start finishing projects.

    Now condos are down 5.1% over the past 6 months, dropping more than the downpayment cash they helped provided. If they stay in (most likely), then they’ll be paying into equity that’s disappearing faster than rent.

  • Michael L 5 years ago

    Insured mortgages only as well, so it’s *really* predatory. A household making less than $120k probably shouldn’t be buying a house in this market, especially in Toronto or Vancouver. The payments, even with a reduction, are likely to consume way over 30% of their income.

  • kwo 5 years ago

    Fascinating move. Can someone explain why builders won’t just take advantage of this by bumping up prices for the relevant units by 10%?

    • Ethan Wu 5 years ago

      Mortgage sizes are capped at 4x income to avoid carriage trade dealings. So yeah, they will take advantage in markets that aren’t Toronto and Vancouver. Free handouts to Calgary’s developers that have been sitting on inventory, pretending it’s not selling because of B-20.

      • kwo 5 years ago

        Exactly, with relevant units being “not in toronto/vancouver”. But it seems like any existing condo / house that would cost less than $400K (or so) today would sort of make sense to boost the price 10%.

        • kwo 5 years ago

          By “existing” I meant “developer’s existing plans to build”.

  • SUMSKILLZ 5 years ago

    What about places that did not bubble, but got burned by B-20? Could this be seen as payback for taking collateral damage from a policy aimed at large city regions in Canada? Lets say in Morrisburg Ontario…

    The figures floated do nothing for folks living in big cities, so it has to be aimed at others, though that was not stated. It seems like a ploy for rural votes.

    • Mica 5 years ago

      Mortgage industry fibs. Most other markets aren’t impacted by B-20, because the income to home price ratio isn’t as out of whack.

      All of those Albertan MLAs complaining about it always fail to mention that Alberta is just coming off of a 22 year high for unemployment. You get a job for a year, you can’t exactly by a house – even though the wages are decent.

  • Fraser 5 years ago

    just like daddy…how can we squeeze every penny from you, because we need more of your money our buddies…especially quebec…take, take, take…and of course more debt…big, big pop coming…get out of debt asap

  • Greg 5 years ago

    Hope prices fall soon – Sold my Downtown Toronto Condo in October 2018 – renting now. But after I paid:pay real estate commissions, legal and moving costs and the land transfer on a new buy – I need prices to fall 10% minimum.

  • Grim Reaper 5 years ago

    The Liberal budget won’t help first time buyers in downtown, midtown, uptown, Toronto.

    • M.Bury 5 years ago

      Libs could probably defecate all up and down Young St and not lose a Toronto vote, anyway. Like another poster said, this is targeted at other areas where they will need help in October.

    • Slowly Boiling Frogs 5 years ago

      Sure it will, as long as they move to downtown, midtown, uptown Halifax.

  • Julio Faria 5 years ago

    This plot has been working in the UK for a few years, and the developers have had excellent profits! Here is a UK article on it. Home buyers be very wary!!

  • Joe 5 years ago

    First-time home buyers with a household income of less than $120,000/year can qualify. The mortgage amount needs to be less than 4x the household income, and you pay it back upon selling.

    Does this mean the max mortgage is 480k? With that in mind, can you buy a 1 mil house and put down 520k and still qualify for this? In that case, how would the equity proportion work? Say they pay 5% of the 480k mortgage…that’s 2.4% of the actual price of the 1 mil house…do they then get a 2.4% stake of the house?

    I am sure this strategy was targeted at first time buyers buying properties around 500k…I guess that will further push up prices for 1 bedroom condos in Toronto? Other property types are way above 500k in Toronto.

    • Mike 5 years ago

      it has to be a CMHC insured mortgage I think. If you’re putting more that 50% down you likely won’t have it insured.

  • S 5 years ago

    Alarm bells were going off in my head as I was reading the announcement of this program but my less-than-MBA-level-financially-educated millennial brain couldn’t quite figure out why. My first thoughts revolved around how this was nothing more than a bail-out for real estate developers, turns out my uneducated speculation was more or less on-point, if a bit short-sighted. Maybe I’m smarter than I give myself credit for.

    Your analysis makes this first-time homebuyer program out to be even worse than I first believed though. What confuses me is who it’s aimed at. To qualify, my read is that household income has to be under $120k/year and the mortgage can’t be any more than 4X household income. Given pricing in Canada’s large cities (Calgary and Edmonton excepted, for now) none qualify. That instantly disqualifies a hefty proportion of millennials (hate that word) given that more of us live and work in those large cities than not. I suppose the “country” millennials might benefit, only problem there being that given the salary discrepancies between large Canadian centres and “the country” I doubt most could get bank approval for any mortgage large enough to afford a livable place. So, who is this program for? My only other thought is that it’s basically a hand-out to millennials and others living in Alberta who still have jobs. Except that their household income is likely to be higher than $120k/year so… we’re back to square one here.

    Meanwhile, no details on how CMHC’s stake in your property will work upon sale. Will they be payed out the original investment plus their % of the property’s gains? Will they absorb their % of the loss, should there be one?

    I can’t help but think that this program is designed to make it look like the Liberals tried doing something when our economy crumbles.

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