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House Prices In Canada Are Now Under The Control Of Global Forces

An IMF study warns local housing markets are at increasing risk from external shocks, but government policy can change that.
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Housing markets, most realtors will tell you, are local. When it comes to residential real estate, Vancouver is nothing like Halifax, which in turn is nothing like Quebec City.

Each housing market reflects the realities of its community: Prices for the most part reflect what people are earning, and how much they can get a mortgage for.

But what if this system were to break down? What if housing markets began to behave like stock markets, their movements no longer reflecting the economic reality of the community, instead rising and falling on the whims of the global investor class?

According to a new report from the International Monetary Fund, this is exactly what's happening. House price trends from London and Tokyo to Sydney and Toronto are becoming increasingly synchronized, the IMF's research has found. The "global factor" now accounts for more than a third of the price composition of housing in advanced economies, the report found.

Look: Average home prices across Canada

"As a result, housing markets in one country are more sensitive to swings in another," the IMF said on its blog.

This is something many of us in Canada suspected was happening as we watched the influx of foreign investors into Toronto and Vancouver (and now, it seems, Montreal).

It may help to explain how Toronto's house price index doubled between 2011 and 2017, even as household incomes grew by single percentage points. It may also explain why house prices in Vancouver are still rising, despite higher mortgage rates and tough new mortgage rules that have pushed one-third of would-be buyers out of the market.

Simply put, what's going on in a local economy may no longer be reflected in the price of housing. And that could be a real problem, because unlike other assets like stocks and bonds, housing is also a basic necessity of life. The decoupling of living costs from local economic realities could create massive disruption to households' quality of life.

Picture a situation where Canada's economy slows down and households are in a tougher financial situation. But foreign investors keep pumping money into housing, raising prices and making an already dire affordability situation even worse.

Or, conversely, picture a situation where everything is going along smoothly in Canada, but a recession in Asia reduces the flow of cash into the housing market, causing a housing bust — and resulting in a recession in Canada.

"Policymakers cannot ignore the possibility that shocks to house prices elsewhere may affect domestic markets," the IMF report states.

"Heightened synchronicity of house prices can signal a downside tail risk to real economic activity, especially when taking place in a buoyant credit environment."

But before you throw all the blame on China's nouveau riche, it's worth noting that the IMF sees a number of reasons for this trend, beyond simply foreign buyers:

Corporate money flowing into the housing market. "Institutional investors, private equity firms, and Real Estate Investment Trusts have been increasingly active in major cities such as Amsterdam, Sydney, and Vancouver as they seek out higher returns," the IMF said on its blog.

Globally co-ordinated interest rates. "The world's major central banks have kept interest rates unusually low for a long time in a bid to stimulate growth," the IMF says. "That has produced a ripple effect of low borrowing costs, including cheap mortgages, across the globe, which has helped push up prices."

A more synchronized world economy. "In 2017, growth picked up in 120 economies, accounting for three-quarters of world GDP," the IMF noted. "It was the broadest synchronized growth surge since 2010."

Intervention works

Fortunately, the IMF report found that government policy can be effective in decoupling housing markets from global trends.

"Policy actions to cool down hot housing markets remain effective and can have the additional benefit of taming house price synchronicity," the IMF said. "Such actions include raising property taxes and stamp duties and limiting the size of a home loan in relation to a home's value."

That's pretty much exactly what various governments in Canada have been doing. Both British Columbia and Ontario have introduced foreign buyers' taxes in the hottest property markets in those provinces, while Canada's federal banking regulator, OSFI, has in effect "limited the size of a home loan" by introducing "stress tests" on mortgages that reduce home buying power by about 20 per cent.

The decoupling of living costs from local economic realities could create massive disruption to households' quality of life.

Associations representing real estate agents have been calling on governments to pull back on these policies, arguing they are harming the housing market. And indeed the latest numbers do suggest a significant slowdown in the market in the wake of the new mortgage rules.

But the IMF's findings suggest these new rules may have been a good idea after all — and if housing markets still continue to decouple from local economies, more regulatory action may be called for.

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